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Mobile payments: regulatory landscape
What is a mobile payment?
In essence, a mobile payment is a payment that is effected in a way which at some stage involves a mobile phone. This, obviously, is a very broad definition. The one thing that unites nearly all mobile payment models is that each of them contains four elements:
- A handset (“device”)
- An account containing the user’s funds (“account”)
- A means of communicating the user’s desire to transfer funds (“communication”)
- A connection to the user’s funds account enabling the transfer to take place (“connection”)
Each of the above elements can take multiple forms depending on the payment model, and the areas of regulation that need to be considered will depend on exactly how each of these elements is realised in the technological process.
It is difficult to describe in any definitive way what the regulatory regime for “mobile payments” is because there are simply so many different processes, mechanisms and technologies — or “payment models” — which fall under this often misunderstood term, each of which occupies a different place in the regulatory landscape.
There is currently no legislation which is specific to mobile payments or m-commerce, although mobile has been very much in mind in the drafting of the existing legislation, and the European Commission has plans to look at this area in more detail.
The main pieces of legislation which affect mobile payments most directly at the moment are:
- The Payment Services Regulations 2009, (PSRs), which are the UK implementation of the Payment Services Directive (PSD) 2007.
- The proposed second Payment Services Directive (PSD2), which at the time of writing is being considered in the European
- The Electronic Money Regulations 2011, (EMR2) based on the second Electronic Money Directive.
Deciding which of these pieces of legislation will apply to a given mobile payments solution will depend entirely on the particular payment model being implemented and the technological processes and money flows behind it. Deciding to whom the legislation applies is a matter of working out exactly where each entity sits in the chain of actors involved in bringing each payment model into action, and whether its function in that chain is itself subject to regulation.
One of the interesting aspects of the mobile payments area is that it brings together:
(a) Payments legislation that has been designed to allow new participants from areas outside traditional financial services into the payments space.
(b) Other areas of regulation that were previously only tangentially related to financial services, in particular regulation relating to consumers, telecoms and certain aspects of personal data (e.g., location data), which will constitute a regulatory overlay to the financial services core.
These other areas of regulation will be focused on in part two of this article. However, what follows here is a brief overview of the main pieces of payments legislation and some analysis of what these regulations mean for the development of the market.
Payment services regulations 2009
The core of the PSRs is that they provide a platform from which entities other than traditional financial services providers can become authorised to provide and execute payment services. This opens up the payments market to new players and facilitates convergence in the mobile payments space.
Will the PSRs apply?
The definition of “payment services” is broad, encompassing money remittance, the operation of payment accounts and the execution of payment transactions through a payment card or a similar device, among other things.
Even when the various definitions have been understood, however, the question of whether or not the PSRs will apply will still depend on the precise function of the relevant party. For instance, the PSRs do not apply to:
The activities of technical service providers that do not at any time hold the funds being transferred. This is likely to be a significant exclusion for many of the participants in the transaction chain who provide purely technological support (including those who provide authentication, data processing and storage services).
Payment transactions executed “by means of any telecommunication, digital or IT device” where the operator of the same is acting as more than an intermediary, i.e., is adding value in some way. This is known as the “value-add” exemption. This is currently an important exclusion as it potentially allows certain payment models to escape the need for authorisation/registration if they add some value to the transaction.
Services based on instruments that can be used to acquire goods or services:
- Only on the issuer’s premises.
- Under a commercial agreement with the issuer, either within a limited network of service providers or for a limited range of goods or services.
This is known as the “limited network” exemption.
Obligations under the payment services regime
If, having waded through the various parameters of what does and does not constitute a payment service, an entity finds that it is providing a payment service and that the PSRs do apply to it, it will have to comply with the relevant obligations imposed by the
PSRs, which differ depending on whether the entity is to be classified as an authorised payment institution, a small payment institution, an e-money issuer or a bank / building society. These obligations include the holding of capital, the imposition of certain contractual terms and various reporting obligations.
The scope of the regulations is fairly broad, and in some respects intervenes in areas that might normally be viewed as falling within the remit of contract and/or consumer rights. The requirements of the regime, plus the fact that to carry on a payment service without the proper authorisation/registration is a criminal offence, means that consideration of the precise function and nature of each entity within a payment model is crucial.
Electronic money regulations 2011
The concept of e-money is by no means new. However, the advancement of technology has broadened the scope of e-money such that it is now found in a range of different technological solutions, including some of the mobile payment models.
What is e-money and how is it different from other payment services?
By way of reminder, e-money is defined in Regulation 2 of EMR2 as follows:
“Electronically (including magnetically) stored monetary value as represented by a claim on the electronic money issuer which:
(a) is issued on receipt of funds for the purpose of making payment transactions;
(b) is accepted by a person other than the electronic money issuer; and
(c) is not excluded by regulation 3.”
Regulation 3 contains two express exclusions. These are in essence the same as the “limited network” and “value-add” exemptions under the PSD.
The interesting thing here is looking at what does or does not count as e-money as you tweak a given mobile payments solution. So, for instance, a closed loop payments system (the Starbucks app) may well not fall within the scope of e-money if the funds on the app are not “accepted by a person other than the electronic money issuer” (i.e., Starbucks itself), but as soon as you allow the app to be used outside Starbucks, or at least outside the ephemeral concept of a “limited network”, it will be e-money. Conversely, a handset used to access a mobile payments platform whereby a data connection is needed to access an online banking app will not constitute e-money (as the monetary value is not “stored” on the handset), but if you allow it to “store” value on a near field communication
(NFC) chip for those times when no data connection is available, then suddenly the regulation will take hold.
Obligations under the e-money regime
In any case, the e-money regime closely resembles the payment services regime in many respects. It too is designed to open up a branch of financial services to non-traditional financial services providers, imposing a similar regime of requirements to that found under PSD2, and with criminal sanctions attached to certain breaches. Nonetheless, for all the similarities, the regimes are different and require separate consideration.
What do these pieces of regulation mean for mobile payment models?
There are of course many effects of a set of regulations as extensive as this, but in broad terms the principal effects appear to be these:
(a) The regulatory door is open for non-banks to enter the payments market, in some form or other. The obvious candidates are those who already fulfil one of the four elements of device, account, communication and connection. For instance:
(i) The banks are already in an excellent position to take advantage of the opportunities in mobile payments: they already have the accounts and, through existing mobile platforms, the connection, and the likes of Paym add the device and communication elements.
(ii) The advent of Apple Pay is no surprise at all, given the size of the payment card database they already have in place through iTunes, and the deep market penetration of the iPhone: Apple has had all the ingredients for the four elements of communication, device, connection and (albeit indirectly) account in place for some time, plus phenomenal brand presence, and so the scene was set for them to enter the market with some conviction. However, it remains to be seen how Apple Pay will fare in the UK, where EMV is ubiquitous and card fraud is low, compared with the US where the lack of EMV means that there is a much clearer fraud-reduction business case for Apple to take to the banks.
(iii) The mobile network operators have the device, connection and communication abilities already in hand, but to create accounts that they could use for payment services purposes they would need authorisation under the relevant regime, and would have to battle with the rigors of AML regulation or otherwise team up with banks that had been through those processes already.
(b) The scope of application of the regulations will depend on the precise nature of the payment activity being facilitated. Those facilitating transactions remotely using some aspect of, or data collected by, a smartphone only as a means of authentication may well need to be authorised as payment service providers. However, where the transaction does not happen remotely but rather by virtue of a connection with a local store of funds through, e.g., an NFC chip or app, the facilitating entity is more likely to need authorisation as an e-money issuer.
(c) There will be a number of important functions in any mobile payment model which are exempt from authorisation, including many of the technology providers who provide services, hardware and/or software which facilitate payments, but never hold funds themselves. However, even these providers should be aware of the parameters of regulation so as to ensure that they do not inadvertently stray into regulated territory.
There may be many entire mobile payment solutions which need no authorisation at all (e.g., the Starbucks app) but development of these will have to be watched closely to ensure that regulatory boundaries are not crossed as new ideas on technical functionality and operation are introduced.
Conclusion: challenges and opportunities
Although the payment services and e-money regulations are a huge step in opening up the market, their complexity is such that the banks and other traditional financial service providers — which already qualify under both regimes — still have the advantage, and can perhaps afford to be more innovative and adaptive without fear of crossing over the boundary from one regime into another.
However, this is by no means to say that there is not a very significant part for others to play in this market, just that they may have to be cognisant of the interplay between product development and regulatory pitfalls. In part two of this article, we will look in more detail at how other areas of regulation around data, AML, security, payment systems and roaming are set to provide both challenges and huge opportunities for a range of players in this rapidly developing market.
For more information, please contact Chris Hill.
This article was originally published by Payments Compliance.