On June 28th, I spoke at EPA’s Pay360 Digital Payments event on the impact and opportunities of PSD2 for payment processing companies. This first post is part of a 3-series blog on this topic.
What is the impact of PSD2? With the help of PSD2, new players acting as Third Party Provider (TPP) are given a powerful position (or an equal playing field in the words of the European Commission). For the incumbent market players, the word is that the world is ending with PSD2. Banks will need to invest extensively, while on the other hand their existing revenue streams will be reduced because of the whole new wave of competitors.
A few quotes from impact assessment reports: “Banks could lose 60% of retail profit to fintech startups” (McKinsey). “95% of respondents believe that at least some of their business will be taken by fintech players” (PwC). “Established financial players who will put in minimal effort to comply with PSD2 will lose the most revenue in the end” (Accenture).
All news, articles and reviews about the upcoming PSD2 so far are mostly about two camps: Fintech vs Banks…but what does PSD2 mean for payment processors, a market player that should not be forgotten?
Rather than looking at PSD2 as another compliance project, what more can it bring for payment processors?
Reach of PSD2: Do We Even Know?
First and foremost, it is important to get an understanding of PSD2’s reach. Only after that can we rightfully look at impact and opportunities. However, the reach of PSD2 is still not fully known. And with that the impact. Let’s clarify this statement with an example. PSD2 refers to payment accounts, and this word is even mentioned nearly 90 times. But what is a payment account? The directive’s definition is vague: “an account held by payment service user used for payment transactions execution”. What does that mean? Yes we can safely state that a payment account is a bank account. But would a credit card account, a virtual account held at payment processors or an e-money account also constitute a payment account? The PSD (both 1 and 2) do not give much guidance. However, an Impact Study of PSD(1) already in 2013 reveals that it is expected that this ambiguity will be a key area where a negative impact is to be expected over the coming years. “What constitutes a “payment account” from the perspective of non-bank providers could result in those providers being faced with greater regulatory obligations when providing payment accounts along with other payment services.” This has not been resolved with PSD2. Has the EC itself given us some guidance? The EC clarifies in its Q&A that the definition of a payment account covers all accounts where the holder can place and withdraw funds without any additional intervention or agreement of his payment service provider such as current accounts. This does not give much more clarity than the definition provided under the Directive.
Local Interpretation: Strict or Broad?
While in the Netherlands, both the regulator and the industry seem to have a strict definition (payment accounts are limited to bank accounts), the FCA in the UK takes a broader view. The FCA finds the following factors relevant for the determination what constitutes a payment account:
- the purpose for which the account is designed and held out;
- the functionality of the account (the greater the scope for carrying out payment transactions on the account, the more likely it is to be a payment account);
- restrictive features relating to the account (for example, an account that has notice periods for withdrawals, or reduced interest rates if withdrawals are made, may be less likely to be a payment account);
- a limited ability to place and withdraw funds unless there is additional intervention or agreement from the payment service provider (this will tend to point more towards the account not being a payment account); and
- the extent to which customers use an account’s payment service functionality in practice.
Accordingly, in the FCA’s view, ‘payment accounts’ can include: e-money accounts, flexible savings accounts and credit card accounts. The FCA also states that only the features of the account used for the purpose of making transactions, to which the regulations apply, fall within scope. For example, in the case of a current account mortgage, the mortgage element of the account would be out of scope, albeit that a mortgage payment from the current account would be subject to the regulations.
It is all still very confusing. There is a definite need for a list of examples from the regulators at an EU level. Without this, there is a great risk of different interpretations at domestic levels in different countries, which will do the industry more harm than good. But think about it: what would consumers what the payment account definition to encompass? For them the broadest scope might be best. It is interesting to see that already the definition of such an important word will have tremendous impact to the post-PSD2 world.
Payment Processors Will See Increased Competition from Unexpected Corners
To conclude, the full impact is still unknown but for sure PSD2 will have tremendous impact. Competition in the payment industry is already severe – but it can even get worse. Payment processors see continuous pressure on their turnover due to increasing competition and decreasing margins. The market is already very fragmented. The future is not much brighter. Payment processing can come from unexpected corners! Not only the TPPs, but also merchants are allowed to initiate a payment order if the consumers authorizes him. What about the card schemes? Visa has been required to split its issuing operations from its processing. Non-EU companies are announcing their launch in Europe more and more. Who else might come? Competition will only become more severe.
So what should payment processors do? They need to re-think how they can break free of their traditional model. Tomorrow, in part 2 of 3 of this PSD series, I will discuss specific opportunities payment processors may potentially have under PSD2.
PSD2 strengthens the positions of existing and new FinTech companies providing account servicing solutions, by given them the right to access payment accounts held at banks, which would look like this (inspired by Innopay´s blog on XS2A):
Opportunity 1 – Payment Initiation
The first should not come as a surprise: become a TPP yourself. What does it look like to be a TPP? Now, replace the TPP with PSP (see second picture below). Expand your reach to consumers – the customers of your clients. Eliminate the need of connecting to alternative payment method suppliers. Initiate a payment order at the request of the payment service user with respect to a payment account held at another payment service provider (bank). Would this not reduce transaction and authorization response times, since traditional payment participants like banks but also merchant acquirers are bypassed?
Opportunity 2 – Beyond Account Servicing
Let’s take a step further. PSPs could strengthen their position with their merchants further by acting as account information providers themselves. The customer would no longer be the consumer, but the merchant (see third picture below). You would connect directly with all merchant’s banks to give merchants full insight in all their bank accounts held. Rather than just a payment system, youmay well become a full-force treasury system, aggregating its own data and balances with all other bank balances and allowing payments to be made via that interface as well. You would not only be a PSP for the merchant, but also their TPP. But with that double role of PSP and TPP, the full extent of those opportunities is yet to be understood.
Think about it. If you can access the transactions on the merchants’ bank accounts what else can you do? What if you have a merchant that you want to take onboard, but there are concerns about its high chargebacks and refunds levels? Perhaps you should choose to act as gateway and have the acquirers settle directly into the merchant account. With your access to those accounts as TPP, you can still reconcile the received payments and provide all reporting services as if the payments were received on your own accounts. No longer holding funds, but still being able to offer a reconciliation (so called ´full service’), should result in the PSP no longer carrying chargeback and credit risks. Not only can the access allow PSPs to reconcile, it is also able to acquire insightful data about merchants, which offers additional cross selling opportunities; tailored propositions based on usage data with great analytical capabilities. The more data a party has, the more it can do for its customers, right?
Opportunity 3 – Operating Payment Systems
Article 18 of the PSD2 (old article 16 PSD) provides what other services besides payment services payment institutions may undertake, such as the operation of a payment system (without prejudice to article 35). But what is a payment system? It is a “funds transfer system with formal/ standardized arrangements & common rules for processing/clearing/settling payment transactions”. Then which systems would fall under this definition? To me that would be SEPA, Visa, Mastercard etc. Whereas 49 of the Directive states “Those payment systems typically include the four-party card schemes as well as major systems processing credit transfers and direct debits.” This conforms to the examples given.
It is interesting to note that this clause already existed under PSD1, but it never got the proper attention and impact review it needed. The very first draft of PSD1 stated that PSPs would be allowed to “access and operate payment systems for the purposes of transferring, clearing and settling funds, including any instruments and procedures relating to the systems. In later draft versions, the word ‘access’ was removed. Could the word ‘operation’ mean that a PSP may establish a payment system competing with the existing systems? I would argue so, in particular because it even used to include the word ‘access’ to and therefore a clear distinction was made between accessing and operating. Operating means performing, conducting, carrying on. Interesting to see how it seems like the carefully considered word has not created any discussions so far during the drafting phase and PSD1 on what it effectively means. PSPs are able to compete directly with the payment schemes? Let’s see if this is picked up by any market players under PSD2.
Opportunity 4 – Access to Payment Systems
Article 18 also refers to article 35 PSD2 (article 18 PSD1) which stipulate that payment systems may not discriminate between authorized and registered PSPs. Whereas 49: “It is essential for any payment service provider to be able to access the services of technical infrastructures of payment systems. In order to ensure equality of treatment throughout the Union as between the different categories of authorised payment service providers, according to the terms of their licence, it is necessary to clarify the rules concerning access to payment systems”
Whereas 50 continues: “Provision should be made for the non-discriminatory treatment of authorised payment institutions and credit institutions so that any payment service provider competing in the internal market is able to use the services of the technical infrastructures of those payment systems under the same conditions.” To give non-banking parties the same access as banks. But what could this article further mean? In the whereas of PSD2 there is explicit reference to 4 party schemes as payment system. In four party schemes there are differences between authorized PSPs (being the acquirers) and registered PSPs (the PSPs registering as MSP of PF for instance). So would that mean that the difference between acquirers and payment processors is blurring? No more certifications or licenses to become authorized member or participant? In the market, you see acquirers already moving into the PSP work space and combining the two roles. Could however PSD2 mean that payment processors have direct access to the card schemes, a right that should not be limited by different conditions and where discriminatory treatment is prohibited from a regulatory perspective?
It seems like the distinct walls of carefully selected and distinct roles by (card) schemes could potentially crumble, but the actual impact and effects of this article in PSD2 is still to be seen. The legislator feels the same. Article 108 of PSD2 states that the Commission shall, by 13 January 2021, submit a report on the application and impact of this Directive, and in particular on access to payment systems. The legislator too believes that first some years must pass after PSD2 implementation before a full impact assessment can be made. I am curious to see how Visa and MasterCard would respond to any PSP knocking at their door to get equal membership rights as acquirers. Or will PSPs be hesitant to challenge the status quo?
There is still a great amount of concern about the details of PSD2 and how the new world post-PSD2 would look like. Nobody seems to know. It seems like even the legislator does not fully understand the impact of PSD2. As I have shown, certain PSD2 articles can be interpreted in different ways from different perspectives and the full impact is still unknown. The interpretations might be a bit bold and would be true game changers. Let’s see if this is picked up by the industry. However, payment processors should not just treat PSD2 as a compliance project and just sit back and wait. It is worthwhile to assess new possibilities to protect the client base and market position by extension of services and reach.