Wednesday, June 21, 2017

Adyen: the new bank is not a bank any more

City giro Amsterdam: not a bank, but nice picture and looks like one
Source: City Archive Amsterdam
Dutch bank registers show that, since the end of April this year, Dutch payment institution Adyen has officially acquired a banking license. This is clearly part of a bigger picture that shows ICT-based companies moving in a similar direction. Many years ago we could already witness the e-money institution Paypal become a bank in Luxembourg. Most recently Klarna also turned from payments institution to a bank. Now what could be driving these companies towards the bank license?

A ‘payments bank’
A closer look at the register tells us that Adyen is licensed for: taking deposits, providing loans, payment services, issuance and management of other payment instruments, foreign currency and issuance of e-money. I would call this a ‘payments bank’ as it demonstrates a clear focus on facilitating payments rather than covering all financial services (which is the case for challenger bank Bunq).

The move towards a bank does of course mean that own capital needs to be increased and some further obligations kick in, such as registering for the deposit insurance scheme. Also, despite the focus on payments, Adyen will need to provide some loans, in order to fulfil the definition of a bank in the legal sense: taking deposits and providing loans.

Now, let’s also look at the further practical consequences:
a- scope discussions for payments solutioning,
b- connections to clearing and settlement,
c- counterparty risk for corporate customers.

a-scope discussions for payments solutioning
Payment institutions that operate under the Payment Services Directive always need to be aware of the nature of the services that they provider. Does it qualify as money remittance, executing payments, executing payments with a credit line or placing money on an account? For each customer that seeks a bespoke solution to a business problem, the service offering needs to be qualified and business rules need to be applied accordingly. Banks on the other hand can more easily engage in the solution domain, given that any setup that involves holding funds and transferring those, will be possible under that license.

Now, payments institutions may of course be well accustomed to the scope and qualification work, so at the end of the day, this part of new business development may not be the source of a lot of head-ache. Still, it might be helpful to bring an end to discussions with local supervisors in Europe that might have their own opinions on the exact content of the payments institution license.

b-connections to clearing and settlement
One big difference between banks and payment institutions is that payment institutions are barred access from the RTGS-system of the ECB. The reasons is that the Settlement Finality Directive does not allow for PIs to become a direct member of designated systems. Even though already 5 years ago, the Dutch Ministry of Finance has made it clear that from a policy perspective the Settlement Finality Directive should change in this respect, no further action can be seen on the EU-level.

This is remarkable, as it is clear that we have a deep market for payment institutions, in which values of funds flow (or future funds flow) that may be quite significant. For example, the € 80 billion value of transactions that flow annually via Adyen (2016) comes close to the total value of transactions at the Dutch point of sale which is somewhere near the € 100 billion mark. There seems to be little logic to exclude these flows via payment institutions, from the scope of the Settlement Finality Directive.

In addition, we should not forget that the prohibition to have an account in TARGET2 has an impact on the future instant payment schemes as well. The settlement leg of most instant payment schemes will be organised in such a manner that only participants with access to TARGET2 can be direct members. The implicit competitive advantage of direct access to clearing and settlement is thus carried over into the new world of instant payments as well. Unless of course, the payment institution should choose to become a bank (or the settlement finality directive changes).

c-counterparty risk to corporate customers
In the classic design of a payment institution, the PI holds the customer funds in a separated account at a financial institution. Yet, if the bank where those monies are held goes broke, there is no recourse to the funds whatsoever. So the PI-business model means that all corporate customers have an inherent counterparty risk against the bank(s) that the PI has chosen to use to channel the separated payment flows.

It is well known that in particular larger companies dislike such intermediate counterparty risks. We’ve witnessed this before when Kasbank in the Netherlands was the only settlement bank for the transactions at the stock exchange. That model was eventually phased out. 

In a similar vein I could imagine that the possibility to eliminate this counterparty risk for its customers, may have also been one of the considerations for Adyen to move towards a bank license. In addition, the increased capital base that comes with the bank status could also help in comforting corporate customers. For a company that processes so many transaction annually, the obliged minimum capital base of € 125.000 appears to be somewhat thin.

The new bank is not a bank any more
As the digitalisation of our economy allows for further modularisation of all kinds of services, we see the same thing happening in the financial sector. We can also witness banking and payments regulation adapt to this reality. The first wave of ‘bank-light’ regulation in 2002 allowed for e-money institutions and the second one in 2009 for payment institutions. In both categories the larger players have gradually chosen to obtain a banking license, while some players have started a digital bank from scratch.

With the renewal of the Payment Service Directive and its obligatory open access, it is clear that for payments services the modularisation of services has become the norm. And it may be only a matter of time before we see the other bank business lines open up all the same. With that, the mental image of the bank as a full service provider will gradually disappear. We will undoubtedly see many more new focused banks, such as Adyen, who each excel at their own game within the bank sector.

The new bank is not a bank anymore. 

Thursday, June 08, 2017

Response to FCA consultation: please clarify what will happen to the payment in 'payment instrument' in article 3k?

This April, the FCA launched its consultation on the Implementation of the revisedPayment Services Directive(PSD2): draft Approach Documentand draft Handbook changes. When reading this I was in particular paying close attention to the discussion of the limited network exemption in article 3k.

Background: limited network exemption
The limited network exemption has its background in the fact that many retailer-based shopping or payment solutions exist, that have a function similar to that of a payment, albeit on a local scale or for a limited range of goods. In order not to be burdened with a huge supervisory obligation, the regulator has taken this class of activities out of the scope of the Payment Service Directive and rightly so.

There is a relevant difference between providing EU wide, reachable payment instruments and solutions that solve a specific niche retailer problem. But getting this right in all detail is tough and therefore the wording of article 3k is somewhat vague.
(k) services based on instruments that can be used to acquire
goods or services only in the premises used by the issuer or
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 allows supervisors to apply the article in a sensible way, in line with the spirit of the regulation.

Changes in PSD2: from instruments to payment instruments
The Paysys report of March 2014, describes the following on the evolution of the article:

In its final report on the PSD II (11 March 201412) the ECON Committee accepted the Recital 12 with the statement of the Commission of the existence of “massive payment volumes and values” offering “hundreds or thousands of different products and services” which are wrongfully operating under the exception of the limited networks of the Payment Services Directive (2007/64/EC). In order to improve consumer protection, these huge payment schemes should no longer be waivered.

Therefore, the Commission proposed a narrowed definition of “limited network/limited range” (Article 3 k) and a very restrictive implementation. In general, the ECON Committee followed the proposal of the Commission by taking over uncritically its assumption of the existence of non-regulated “massive payment volumes” in the market.

In phrasing the new article however, something did happen that may have been legally quite relevant. The wording instruments changed into payment instruments. This means that instruments which do not qualify as payment instruments and are not used to deliver payment services under the PSD2, will not qualify.

(k) services based on specific payment instruments that can be used only in a limited
way, that meet one of the following conditions:

  • (i) instruments allowing the holder to acquire goods or services only in the premises of the issuer or within a limited network of service providers under direct commercial agreement with a professional issue;
  • (ii) instruments which can be used only to acquire a very limited range of goods or services;
  • (iii) instruments valid only in a single Member State provided at the request of an undertaking or a public sector entity and regulated by a national or regional public authority for specific social or tax purposes to acquire specific goods or services from suppliers having a commercial agreement with the issuer; 

Effectively this takes out a lot of retailer instruments, which sometimes can be card-based, as they are not truly payment instruments but tools to add purchases into a shopping basket (which can be paid monthly via direct debit payment for example). It also means that petrol cards or fuel cards that are based on a similar mechanism - and may include a chain sale - will not fall under the exemption but can be considered out of scope.

Now, my personal guess is that while this legal consequence is clear, supervisors may want to ignore the relevant adjective 'payments' in order to keep their hold on near-payment mechanisms, even when they are not in scope of the PSD2 and do not fit under this definition. For that reason I was very interested to see what the FCA did with the difference between instruments and payment instruments.

What does the FCA propose to do with this?
It' turns out that in the consultation document the FCA sometimes pays lip service to the original definition, but mostly conveniently forgets the 'payment' part of 'payment instrument' in the definition of 3k. See for example their summary phrasing on page 19:
Limited network exclusion
2.18 Under the PSRs 2009, a business that offers a payment service may be excluded from regulation if its service is based on instruments that can be used only in a limited way to acquire goods or services in certain limited circumstances (often called the “limited network exclusion”) e.g. some gift or store cards.   
2.19 PSD2 aims to standardise the application of the limited network exclusion across the EU, and makes changes to the exclusion which mean it now applies less widely. One limb of the exclusion’s application is narrowed so that it relates to instruments used to acquire a “very” limited range of goods and services (rather than “limited range” set out previously in PSD). A new limb excludes certain instruments provided for social or tax purposes from regulation under the PSRs 2017. Our proposed amendments to Q40 and Q41 in PERG 15 give guidance on the scope of the amended exclusion. 
Then again, the formal notification form does state that the respondent should clarify if the notification tix all the boxes of the law:
Please explain how the product or service falls within the limited network exclusion specified, including details of the following where relevant:
  • the payment instrument; 
  • where and how the payment instrument can be used; 
  • where the customers or users are based; 
  • etc.....
Well, this proposed approach is pretty confusing, so therefore I sent in a reply to the consultation asking to clarify the FCA interpretation of article 3k. In doing so I also referred to the fuel card situation and the set up with chain sales.

Clarify the confusion: are you reading payment instruments as 'instruments' in 3k or not?
We are wondering why the FCA is properly using the delineation payment instruments in a lot of the texts on limited network exclusions, but when it comes down to the actual formulation of excluded activities in Perimeter Guidance, it chooses to forget the word "payments" and sticks to: payment services based on instruments used within a limited network of service providers or for a very limited range of goods or services (“limited network exclusion”). This would create an inconsistency in which the old understanding of limited network is moved towards the new PSD2-interpretations although the legal wording is substantially different.
Should we understand the changed wording to be merely an omission or a situation of intended regulatory scope creep, to include all kind of non payment instruments under the scope of the payments directive? 

When the final document comes in, we'll have a look at the response of the FCA, to see if things have become more clear.