Rationality and irrationality of EU Payments regulation · Rationality and irrationality of ... •credit vs debit-cards • Each country follows its own technical path • Old path

Rationality and irrationality of EU Payments regulation

A closer look at institutional dynamics

Simon Lelieveldt

October 24, 2014

Jean Monnet Module on Europeanisation of the payment system

• 1989-1995: Postbank – ING

• 1996-2001: Dutch central bank / supervisor (DNB)

• 2002-2004: SL Consultancy (e-money focus)

• 2004-2011: Dutch Bankers Association (NVB)

• 2012 - : Independent Regulatory Consultant

• Expertise:• Retail Payments and Retail Banking, switching bank services, regulation

and supervision of e-money: Chipper/Chipknip, Development of E-money & Payment Services Directives, Single Euro Payments Area (SEPA), Financial supervision and compliance (FATF etc)…..

Introduction - Simon Lelieveldt

Todays session…

• A preview of a (pending…) PHd study on the evolution of retailpayments….

- field research into creditcard adoption in NL

- experience as a practicioner in the payments regulation domain

- study of Dutch financial history

- institutional approach to development of regulation….

• As well as a practicioner trying to point out areas and questions of interest for those studying changes in payments regulation

RealityModel

The world as we would like it to be

The world as it is..?

Just some preliminary notes....

Institutional change in theory

Institutional change in practice

Rational Irrational ?

EU Payments regulations….

• Consumer protection rules (1987-2014)

• Competition Cases and regulation (1988-2014)

• Anti-Money Laundering Rules (1991-2014)

• Settlement Finality Directive (1998/2009)

• Electronic Money Directive (2001-2009)

• Regulation (EC) No 2560/2001 of the European Parliament and of the Council of 19 December 2001 on cross-border payments in euro

• SEPA and the Payment Services Directive (2009-2014)

• Payment Accounts Directive (2014)

http://ec.europa.eu/internal_market/payments/crossborder/index_en.htm

First observations…?

Industry dynamics in payments

• The development of payments is alwaysevolutionary

• The six major factors are:• Growth of the economy

• Size/scale of market

• Applicable rules

• Status of technology

• Nature of demand

• Nature of competition

Nature of demand for retail payments

A hygiene factor

A hygiene factor… …. is only relevant when it fails…. is not a fun factor

It’s about something else primarily !

Historic paths of technology development

4268

17

77

11

38

64

12

61

32

64

2

9

0

4

71

27

17

74

30

Franc

ia

Ger

man

yIta

ly

Net

herla

nds

Spa

in

Cards

Cheques

Direct debits

Credit transfers

Size of market

Current technology

Nature demand

Applicable rules • Typical domestic

payment mix:

• giro vs cheque-

countries

• credit vs debit-cards

• Each country follows

its own technical path

• Old path remains

relevant also under

new technology

Payments follow the (internationalising) economy

Scale of market

Nature of demandEconomic growth

Internationalisation Nature of competition(outsideEU)

Domestic percentage in retail payments

DomesticPayment cards

Credit-transfers

Cheques

Cross-border

97 %

3 %

• Retail payments will remain a

domestic market as long as

customer behaviour is

domestic

• Further internationalisation is

the main trend !

Business models: more rational - unbundling

• Historical fee structures are under pressure from new entrants and outsiders

• Gradual move towards cost-oriented fee structures for all segments in the market

Nature of competitionOutsiders

New technologiesNiche focused

• Each product should be viable

• With transparant information provisioning to the customer

25 85654510

40

20

30

60

50

70DE

IT

FR ESUS

BE

UKNL

SEPL

Consumenten

Zakelijke markt Ink

om

ste

n p

art

icu

liere

seg

men

t

Inkomsten zakelijke segment

Bron: McKinsey

Applicable rulesNo state support or cross subsidies

Economic growthInterest rate

Geography

size of market

Demand:

dissatisfier

Suppliers pursuing

efficiency through econ.

of scale and innovation

Constitutional

Infrastructure:

-laws

-regulations

Retail payment

infrastructure:

-payment products

-clearing mechanisms

-settlement systems

Observation of

market leads to

consideration of

intervention

Information

Technology

Economy:

interest rate

Industry domain Constitutional domain

Regulators and

supervisors pursuing

regulatory agenda and

regulatory goals

Public policy domain and interactions

Legal

requirements

Institutional change… the lab experiment

It’s a survivors game, for everyone….

MARKET PLAYERS• want to survive • want to grow bigger• make (and copy) products /

services• make headlines with profit

and loss / innovation• will not enter a market and

then refrain from selling• shape actions based on

historical events/trauma’s

REGULATORS• want to survive • want to grow bigger• Make (and imitate)

regulations• make headlines with rules

and market intervention• will not study a market and

then decide not to intervene (Katz)

• shape actions based on historical events/trauma’s

Institutional dynamics

• At different levels in society, the individual firms/persons, groups of stakeholders, cities, provinces, governments or regions are faced with events and circumstances that lead to (institutional) changes

• Institutional changes may be: setting up an institution or enshrining important rules into legal frameworks.

• Institutional change occurs at different levels

• Source: Kiser, L. L. and E. Ostrom (1982). The three worlds of action: a metatheoretical synthesis of institutional approaches. pp. 179-222. In: Strategies of Political Inquiry. E. Ostrom. Beverly Hills, Sage.

Individual banksand customers

Consumer Union andBankers Association

Government and Ministriesof Finance / Economic Affairs

Some basic routes for changing laws

• Top Down: an observer chooses to align and streamline the range of diverging practices / rules in order to create a harmonized policy

(the intrinsic desire of any policy maker of any subject area)

• Bottom Up: a practical incident or problem in the operational domain leads to a (knee-jerk) reaction by collective bodies and eventuallyregulators

The power of the centre….

• Both the ECB and the European Commission are institutions that are at the centre of developments

• The centre will in the end always win….

• Central bank discussions on:• Target 1 (decentralised) – Target 2

• Domestic central banks responsible for retail payments…. -- now ERPB

The example of competitors –> first movers

• It is common sense and good practice to observe and learn from the regulatory practices in other countries

• Yet, this may also result in a desire to be the first to market with new legislation (NYC Bitlicense) to beat other legislators

• Drivers may originate from the supervisory bodies or Ministries withingovernments

The power of a threat ….

• Legislator writes an analysis of developments and desired outcome of the market

• Threatens the market/industry with regulation but allows timeframe for self regulation

• Frightened and divided industry will work on self regulation

• Reuglators then use (and possibly tighten) the self regulation into a formal legal framework that could otherwise hardly have been developed

The power of institutional memories / deals

• Contraints for design of payment cheques in the Netherlands in the 1960s were based on central bank experiences in 1923

• In 1980 the central bank expressed desire to get its own paymentsregulation law.. It struck a deal with the ministry of finance…. And had to wait until 2014 for the deal to be effected (despite the fact that in the mean time the payment services directive was effected)

The power of persons

• Sometimes an institutional change may be slowed down or move tofast forward due to deciding constellations of power or specificpersons in charge

• Dual payment circuits in NL could have merged already in 1968 but for strategic reasons one side chose not to do

• Thus we embarked on a project from 1986-1998 to merge the technologies to the appropriate national scale

Observations on EU legislation - 1

• Consumer protection rules (1987-2014)• Copying the US approach to cards (Reg E and reg Z)

• Competition Cases and regulation (1988-2014)• Towards regulation of interchange fees… (as in other continents)

• Anti-Money Laundering Rules (1991-2014)• Relevant topic but completely hijacked by the US after 9/11

• Settlement Finality Directive (1998/2009)• Mostly technical stability provision to support euro-zone payment infrastructure


• Electronic Money Directive (2001-2009)• Compromise between central banks (wanting bank rules for new innovative

companies) and ministries of Economic Affairs (in favour of innovation)

• Mobile operators find out they are captured by regulation and seek exemption

• Having paid huge amounts of money for the licenses, they get their exemption

• payment transactions executed by means of any telecommunication, digital or IT device, where the goods or services purchased are delivered to and are to be used through a telecommunication, digital or IT device, provided that the telecommunication, digital or IT operator does not act only as an intermediary between the payment service user and the supplier of the goods and services;


• Electronic Money Directive (2001-2009)• Evaluation of directive:… the market has not taken off….

• So until today …pre paid mobile phone money works as electronic money but is out of the woods of regulation….

• Very interesting case of regulatory capture where the regulator allowsitself to be captured not by the incumbent industry but by a non-regulated industry that uses its channels via Ministries of Transport andCommunications.

• The debate continues on during the PSD2-talks and review of EMD2

Observations on EU legislation – 4

• Regulation (EC) No 2560/2001 of the European Parliament and of the Council of 19 December 2001 on cross-border payments in euro• Overstepping the formal legal reach, but supported by political momentum the EC stepts

into price regulation for banking transfers

• Underlying thought is to force banks into more efficient and proper conduct in the payments market

• Bigger banks see opportunity to outsmart smaller local retail banks with their panEUprocessing centres and align with EU Commission to develop EU standards

• Complex game of bigger/smaller banks slowly moving forward towards technicalharmonisation

• Request of banks to make harmonised legal framework is joyfully honoured by European Commission - leads to the PSD


Observations on EU legislation – 5

• Payment Accounts Directive (2014)• Classic example of power of the civil servants at Commission

• Set up joint group of experts – promise an impact assessment

• Skip impact assessment and throw longstanding desire for panEuropeanswitching into policy plans for EU market

• Wait and slowly move the process forward, duck the impact assessment issues

• Time a draft legislation one year before EP dissolves and hope that they wish toget political momentum/impact with it• Directive 2014/92/EU on the comparability of fees related to payment accounts,

payment account switching and access to payment accounts with basic features

• Goal achieved: in the SEPA-harmonized area where one bank account is enoughthere is now also the opportunity to open bank accounts in each member state

Rationality and irrationality

• The institutional process is rational in the sense that there is a institutional power rationale and dynamics at work that has similarcharacteristics time and over again

• The outcome is irrational in the sense that the proclaimedconsiderations / intentions do not always match with the end result in terms of legislation

Thank you !

Settlement Finality Directive(s) - 1

Which rules?

• Directive 98/26/EC of 19 May 1998 on settlement finality in payment and securities settlement systems and Transfers (Settlement Finality Directive)

• Directive 2009/44/EC of the European Parliament and of the Council of 6 May 2009 amending Directive 98/26/EC on settlement finality in payment and securities settlement systems and Directive 2002/47/EC on financial collateral arrangements as regards linked systems and credit claims

Settlement Finality Directive(s) - 2

Main reason:

Elimination of the zero-hour rule that should apply when certainpayments are revoked/reversed given that a company or person is declared insolvent

A technicality, but an important one….

Trigger:

Ensuring financial stability (mostly domestic focus)

Bank

Users

Central bank

Settlement

Transport and clearing of, Payment instructions

Users

Market for payment services and products

Users

Bank

Payment products

Payment products, clearing and settlement

Users

Payment products

Clearing house

Market for clearingand settlement

DNB

bank A bank Bretail

payments

Customers

l

netting

BuBa

ECB

retail

paymentsbank C bank D

netting

International setup

Domestic

Settling payments individually (gross)

bank A bank C

bank B bank D

40

2060

30

7090

10

80 50

Number of settlement payments: 9

Totale value of payments: 450

bank A bank C

bank B bank D

40

40

30

20

7050

Number of payments to settle : 6

Total value of payments : 250

Settling payments via netting

bank A bank C

bank B bank D

Number of payments to make: 3Totale value of (split) payment : 130

Clearing

house

130 30

100

Settling payments via multilateral netting

Settlement Finality Directive - 3

• What does it do?

• Designate specific large value systems and retail payment netting andsettlement systems and institutions that participate,

• Payments that are done via these designated systems are final andcannot be unwound due to insolvency proceedings

Settlement Finality Directive - 4

• Renewal – update via Directive 2009/44/EC

• Motivation:• Account for interoperable – interconnected systems (security settlement)• Ensure usage of credit claims as collateral

• Remarks ?

• No upcoming changes planned, but might be relevant for paymentinstitutions and electronic money institutions

Agenda

• 1800-1930:• Settlement Finality Directive (1998/2009)• Electronic Money Directive (2001-2009)• Consumer protection rules (1987-2014)• SEPA and the Payment Services Directive (2009-2014)• Anti-Money Laundering Rules (2005-2014)• Competition Cases and regulation (1988-2014)

• 2000-2100:• Industry dynamics in payments• Case: regulating bitcoin in Europe?

Electronic Money Directive - 1

Which rules?

• DIRECTIVE 2000/46/EC OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL of 18 September2000 on the taking up, pursuit of and prudential supervision of the business of electronic money institutions (First EMD)

• DIRECTIVE 2009/110/EC OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL of 16 September 2009 on the taking up, pursuit and prudential supervision of the business of electronic money institutions amending Directives 2005/60/EC and 2006/48/EC and repealing Directive 2000/46/EC (Second EMD)


• Main reason

• Allow niche-businesses to operate e-money products under a specialised credit-institution regime

• Triggers

• Development of chipcard-money, Internetbased e-money

Emergence of digital or e-money (1990s) - 1

• Initial regulatory response:• Protecting the (value of) fiat currency• Buying pre-paid value is the equivalent of taking deposits

Emergence of e-money (1990s) - 2

• International coordination: • Reports on security /impact of electronic money (1996)

• Local regulatory differences:• US: Money transmitter based frameworks vs national

legislation• EU: discussion on restriction to banks or opening up the

market• Electronic Money Directive: specialised credit-institution

Emergence of e-money (2001) - 3

• Early topics:

• Pegging the value to fiat currency (1:1 conversion)

• Is electronic money ‘in the cloud’ also e-money or shouldit reside on a chip ?

• Do pre-paid funds from mobile operators constitute e-money, yes or no?

Further development of e-money

• Licenses for companies suchas Paypal, Google,

• Strong concentration of e-money industry in the UK

• Stepwise development of pre-paid market and regulation


• What does it do (in 2000) ?

• Create specific supervisory regime for companies that issue electronicmoney (minimum harmonisation)• Competent board of directors, integrity of systems, lower own funds (€ 1

million ) requirement, security measures etc.

• Requires redemption and ensures 1:1 conversion

• Waiver regime for smaller companies and limited networks

• Restricts business to e-money only


• What’s remarkable - Evaluations / Assessments of the first EMD?• Little uptake in the market ….

• Paypal started and …. mobile operators were excluded

• Scope confusion for mobile phone money (hybrid issuers) was a problem

• Exemption phrasing in later times:

• monetary value used to make payment transactions executed by any telecommunication, digital or IT device where the goods or services are delivered to and used through such a device, but only where the operator of the device does not only act as an intermediary between the user and the supplier.


• What changed in the Second E-money Directive?:Revised definition and exemption; mobile money is out

EMI no longer credit-institution, but separate institution

Lower own funds (€ 350.000)

Prohibition on paying interest

No issuing via agents

Other business activities allowed (including provision of credit)

Full harmonisation

Electronic Money Directive – 5

• What’s up next?

• Evaluation of 2nd EMD to determine a.o.:• Economic effects

• Scope effect of limited network rules and waivers

• Use of agents

• Cooperation between supervisors

Agenda



Consumer protection rules - 1

• Which rules?

• Europe could play an Ace: Communication: COM(86) 754 final BrusseLs, 12 January 1987

• Commission Recommendation 87/598/EEC of 8 December 1987 concerning a European code of conduct relating to electronic payments

• Commission Recommendation of 17 November 1988 concerning payment systems, and in particular the relationship between cardholder and card issuer

• Commission Recommendation 97/489/EC of 30 July 1997 concerning transactions by electronic payment instruments and in particular the relationship between issuer and holder


• Which rules - …. ?• Directive 97/5/ec of the European Parliament and of the Council of 27 January

1997 on cross-border credit transfers

• Regulation (EC) No 2560/2001 of the European Parliament and of the Council of 19 December 2001 on cross-border payments in euro

• SEPA regulations and the Payment Services Directive (next block)

• Directive 2002/65/EC of the European Parliament and of the Council of 23 September 2002 concerning the distance marketing of consumer financial services


• Main reasons for the rules are:

• Ensuring legal framework for electronic funds transfers (1988)

• Increased dissatisfaction with banks cross-border processing/cost

• Eliminating cold calling and unsolicited provision of financial services

Consumer protection - 4

• Triggers• Introduction of the euro

• Continued irritation over banks behaviour and cost level

Milestone regulation: 2560/2001

• Prescribing fee levels for banks (identical for domestic and cross-border payments)

• Had a major impact and became the stepping stone / stick to push bankstowards the creation of a Single Euro Payments Area

Consumer protection rules -

• Which changes are now in the making … almost finalised ?

• Forthcoming Payments Account Directive (2014):

Directive of the European Parliament and of the Council on the comparability of fees related to payment accounts, payment account switching and access to payment accounts with basic features (COM(2013)0266

Means:

Obliges use of harmonized terminology, fee information document, fee statement

Obliges payment service providers to facilitate switching, even cross-border

Allows consumers the right to open bank account in each member state

Consumer protection - 5

• What’s remarkable ?• Creating SEPA (one bank account makes EU reachable) vs allowing customers

to open a bank account in each country

• So-called need for Directive on bank accounts and actual leeway for Member States in implementation

• Scope of Bank Account Directive – to Payment Account Directive and halfwayback

• Not using revision of the PSD to change consumer protection and disclosurerules

Agenda



SEPA and the Payments Services Directive - 1

• Which rules?• Regulation (EC) No 2560/2001 of the European Parliament and of the Council of

19 December 2001 on cross-border payments in euro

• Directive 2007/64/EC of the European Parliament and of the Council of 13 November 2007 on payment services in the internal market (full harmonization)

• Regulation (EC) No 924/2009 of the European Parliament and of the Council of 16 September 2009 on cross-border payments in the Community

• Regulation (EU) No 260/2012 of the European Parliament and of the Council of 14 March 2012 establishing technical and business requirements for credit transfers and direct debits in euro

• 2013/0449(COD) - 09/01/2014 Legislative proposal to amend final deadline with6 months



• Main reasons:

• Unified Europe requires further standardisation / harmonisation of legalrules; incorporation of previous conduct rules in Directive,

• A separate supervisory regime required for payment institutions (like e-money institutions, but only for transferring money),

• Desire to cut down processing times for payments (T+3 / T+1)

• Direct debit needed to be included in EU cost-equality rules

• IBAN had to be positioned as a central processing standard

• Agreement on interchange for direct debit (rejects)

• Need for a SEPA-deadline (which can’t be agreed privately)


• Triggers:• Fear for further intervention by regulators lead to bank initiative to create

panEuropean payment mechanism• Large banks saw opportunity to drive out smaller banks and standardise

back-end processing – European Payment Council• Commission saw opportunity to further harmonise/standardise and get

leverage for Payment Services Directive • European Central Bank used the dynamics to gain as much territory as

possible during the process• A complex waltz/tango between:

• Large international banks – European Commission – European Central bank –Domestically oriented banks – Bank associations – Consumer representatives

SEPA – Payment Services Directive - 4

• What do the rules do?

• PSD harmonized:• Conduct / contract rules towards customers

• Creation of separate supervisory regime for payment institutions

• Execution requirements with respect to processing

• Regulations established:• Equal fee level for all payment products

• Technical standards and leeway for interchange fee direct debit

• Deadline – and extension with 6 months of SEPA-deadline


• Which changes underway?

• Revision PSD seeks to:• include third party payment processors as a separate licensed entity

• further detail security requirements

• expand scope geographically (to one leg trx)

• redefine scope of exemptions (agents/limited networks)

• ensure access to bank accounts for payment institutions and e-money institutions


• What’s remarkable?• Level of detail with respect to security definition (copy-paste ECB)

• No contract required for third party payment processor that acccesses bank account of customer via its own technology

• Considerable role for European Banking Authority to further specificy security requirements

Agenda



Anti-money laundering rules - 1

• Which rules?

• Third AML Directive: 2005/60/EC of 26 October 2005 on the prevention of the use of the financial system for the purpose of money laundering and terrorist financing (minimum harmonization)

• Regulation No 1889/2005 of 26 October 2005 n controls of cash entering or leaving the Community

• Regulation (EC) No 1781/2006 of 15 November 2006 on information on the payer accompanying transfers of funds (FATF-7)


• Main reasons:

• Complying with international agreements of the FATF

• Prevent/detect terrorism / criminal behaviour

• Relevant triggers:

• Al-Qaida attacks on New York

• Barriers to business for e-money providers


• What do the rules do?

• Cash-regulation: obligation to declare cash in transit > € 10.000

• FATF-7 regulation: add payer info to the funds transfer, verify payeridentity and addresss omitted information problems

• Third Directive: prohibition of money laundering/ terrorist financing; no anonymous accounts; customer due diligence obligation andsimplified regime for low risk products ; casino rule; monitoring obligations ; FIU ; no disclosure; identify ultimate beneficial owner / politically exposed persons regime /


• Change underway?

• 4th AML Directive• Reduction of simplified due diligence regime

• Alignment with latest FATF-insights (tax crimes are also crimes)

• Find ultimate beneficial owner

• Use risk based apporach – risk assessments at state level

• Delegation of rule-making to: EBA, EIOPA and ESMA


• What’s remarkable?

• The obedience to more US centric FATF-interpretations perhaps…?

Agenda



Competition cases and issues - 1

• Which rules?

• Case (Decision 2001/2002) on MIFs on cross-border transactions on Visa consumer credit and debit cards & on certain scheme rules

• Study (2005) on financial services in the European Union in retail market products and payment cards and payment systems.

• Case (Decision 2007) on MIFs on cross-border and certain domestic transactions on MasterCard consumer debit and credit cards

• Case (Decision 2010) on MIFs on cross-border and certain domestic transactions on Visa consumer debit cards

• And… ……


• Main reasons for cases:

• Behaviour that is a barrier to true competition

• State support leading to unlevel playing field

• Desire for lower fees or elimination of barriers by new entrants

• Political desire to impose competition improving measures


• Main triggers:

• Complaints by market participants, consumer/merchant organisations

• Desire to eliminate different treatment per country

• Introduction and use of international schemes for the move to SEPA (leading to possibly higher fees for merchants)

• Other regulatory bodies leading the way (Australia, US…)

• EC-desire to regulate in EU-rule and consolidate case-law


• Proposed MIF-regulation (2014)

• Places cap on debit-card payments (including pre-paid cards) to become the lower of 7 eurocents or 0,2% of the payment transaction value; cap for credit-card payments is 0,3% of value

• Increased interoperability and separation of schemes / processing is required, EBA gets a role for standards

• Dual branding allowed


• Remarkable?

• The scientific community does not agree at all whether the concept of interchange fees works or doesn’t work; it’s a war of beliefs

• Lots of technical discussions possible on level of fees vs alternatives, tourist test etc.

• European Parliament forbids other ways to get revenue streams for services to merchants

Documents

Rationality and irrationality of EU Payments regulation · Rationality and irrationality of ... •credit vs debit-cards • Each country follows its own technical path • Old path