The Initial Scope Of TheNew UK Payment SystemsRegulator12TH FEB 2015 | WRITTEN BY: PETER HOWITT

1. INTRODUCTION

The UK is pioneering a specialist regulatory focus on payments and e-payments to ensure that it remainsthe European capital for payments, and can also assume a world leader position in new areas ofpayments innovation (e.g., virtual currencies).

The current payments infrastructure and landscape, particularly in the UK and the US, is based largely onthe processes and structures agreed by major banks to deal mainly with banking requirements andinnovations of the last century. For example, the major UK payments card schemes (Visa andMasterCard) arose as a result of card innovation, particularly credit card, and inter-bank arrangementsby a number of banks initially in the US in the 1950-60s.

The established processes of payments clearing, settlement, reconciliation and processing are builtaround systems and processes agreed by and suited to major counterparties who are usually verticallyintegrated into the relevant payment systems. Access to major clearing systems also requiressponsorship by a small number of major clearing banks. However, this is counter-productive to genuineinnovation by competitive and disruptive market players as it makes the emergence of new paymentsolutions difficult, costly and unnecessarily complex.

2. GETTING STARTED WITH FINANCIAL SERVICES AUTHORISATION

As an e-payments lawyer it is necessary to point out to new clients seeking financial servicesauthorisation that their hard work is really only getting started if and when they obtain financial servicesauthorisation. This comment often surprises the less experienced.

Leaving aside the ever increasing regulatory and compliance obligations, the costs and difficulties for

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new payments companies start to multiply when they wish to do business using their authorisation, forexample:

They need to consider payment issuing or acquiring permissions and relationships.They may now need to factor in the licensing and collateral costs and processes for dealing withthe card schemes and card processors.They will need to find willing banking partners to receive and hold client and trading accountfunds.They may need loading and redemption pathways requiring additional relationships with otherpayment partners.They will likely also require relationships to deal with FX transactions.

In short, and assuming they are able to access the payment systems and counterparty relationships theywill need, new payments players have to work very hard and be super smart to make a profit once everyother participant takes its slice of the transactions.

If you add any cross-border e-commerce element to your payment programme, the costs and difficultiesrise more significantly, even in Europe where it is subject to some degree of harmonisation, includingunder the Payment Services Directive and the second Electronic Money Directive. The complexity andmultiplicity of participants, payment systems and regulatory structures in each country creates evengreater barriers to entry and makes many good payment solutions unprofitable, which further reducesinnovation and increases the importance of financing to get scale (for this reason emerging paymentoperators coming in from the US have an advantage over home-grown European innovators).

The existing regulatory architecture also shows its age with some strange anomalies, for example,despite their fundamental influence and importance to worldwide payments, MasterCard and Visa havenot yet squarely fallen within a defined financial services authorisation category in the UK (or mostplaces elsewhere) and yet they set the rules of access and engagement for the world’s commonlyaccepted branded payments cards. The same issue arises in respect of major card processors.

3. STRUCTURAL REFORM AND REVIEW

In “advanced” Western economies, the existing legal framework and payments infrastructure hasevolved, with some work-arounds seeking to enable customers to access new payment productsdevised for new demands (e.g., the authorisation of electronic money products); however structuralproblems persist:

“Innovations in payments are found at the consumer-facing end. However, innovation within paymentsystems, at the Operator and infrastructure levels, appears to have been at a slower pace with changeoften driven by external (sometimes political) pressure.” (PSR CP14/1 - A new regulatory framework forpayment systems in the UK, para 56)

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The payments landscape in the so-called advanced economies is ripe for review and restructuring tobetter enable new entrants and solutions. The proposed new EU Payment Services Directive (PSD2) islooking to deal with some of these issues and the UK has responded to this challenge by establishingthe new Payment Systems Regulator (PSR).

The PSR published a consultation in November 2014 (PSR CP 14/1), which sets out the PSR’s vision andproposed regulatory approach. Responses to the questions raised in the consultation were required tobe submitted by January 12, 2015 — there have been more than 40 public responses (and many moreconfidential responses) from a wide range of UK and international companies and associations.

4. PSR’S REMIT

The PSR is set up as a subsidiary of the Financial Conduct Authority (FCA). The PSR’s aim is to ensurepayment systems and the regulatory framework operate in the best interests of service users and thewider UK economy, promoting rather than constraining innovation and competition.

The initial remit of the PSR is:

To promote effective competition in the markets for payment systems and for services providedby those systems, including between operators, payment service providers (PSPs) andinfrastructure providers, in the interests of service-users.To promote the development of and innovation in payment systems, in particular theinfrastructure used to operate payment systems, in the interests of service-users.To ensure that payment systems are operated and developed in a way that considers andpromotes the interests of service-users.

5. WHO WILL BE REGULATED BY THE PSR?

Under the new PSR regime, HM Treasury will specify those payment systems and participants (such asPSPs) that the PSR will regulate. This approach allows the UK government agility and adaptability tofocus its remit and activities to meet new challenges and new payments systems that may gain commonacceptance. Initially, the PSR will regulate the main interbank payment systems, namely Bacs, CHAPS,Faster Payments Service (FPS), LINK, Cheque and Credit Clearing (C&CC) and Northern Ireland ChequeClearing (NICC), MasterCard and Visa.

The FCA will continue to authorise regulated PSPs (e.g., banks, e-money issuers and paymentinstitutions). Banks are dual regulated by the PRA and so must comply with FCA and PRA prudential andconduct of business requirements. The PSR, therefore, adds a market regulator on top of much of theexisting regulatory environment for the payments sector.

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6. PSR AS AN ECONOMIC REGULATOR

The PSR is being set up as an economic regulator to better manage macro-issues that go across thewhole payments industry and have an impact on the wider economy. The PSR has broken theserequirements down as follows:

Strategic development of industry collaboration and innovation.Regulation of key concerns relating to ownership, governance and control of, and access to,payment systems.High-level behavioural standards for industry participantsDetailed proposals relating to monitoring, enforcement and dispute resolution.Market reviews into the provision of indirect access to payment systems, and into the ownershipand competitiveness of infrastructure provision.

7. PSR INITIAL POLICY PROPOSALS

The initial policy proposals include the following key points:

Strategy:

1. Setting up a new Payments Strategy Forum with broad representation of industry and service-users.

2. Launch a market review into the competitiveness of infrastructure provision commencing by April2015.

Ownership, governance and control of payment systems:

1. All operators (i.e., the regulated payment service systems specified by HM Treasury) will berequired to ensure service-users are appropriately represented in decision-making.

2. Conflicts of interest will need to be addressed in respect of vertically integrated banks andoperators.

3. Operators will be required to report to the PSR on compliance with their service-user directionannually.

Direct access to payment systems:

1. Operators must provide access on objective, risk-based, and in some cases publicly disclosedaccess requirements, which permit fair and open access.

2. All operators must report on compliance with their relevant access rule annually.

Indirect access to interbank systems:

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1. Sponsor banks must publish information on the sponsor services they offer (including accesscriteria and processes). Industry will develop a PSR-approved Code of Conduct.

2. The PSR will launch a market review into indirect access, commencing by April 2015.

Interchange fees:

1. PSR will engage with relevant authorities on the proposed EU Interchange Regulation.

Regulatory tools:

1. The PSR will introduce principles on expectations of industry behaviour.2. Industry must work with the PSR in an open and ongoing basis.3. Issuing powers and processes guidance.

8. PSR POWERS

The PSR’s wide-ranging powers are established by the Financial Services (Banking Reform) Act2013 (Banking Reform Act). Its powers include:

The ability to amend agreements, including the fees relating to access to payment systems.Ordering the disposal of interests in the operator of a payment system.Requiring banks to enter into agreements with other institutions to process transactions on theirbehalf.Investigating and imposing fines (e.g., based on revenue or payment volume) or other sanctions.Use of competition powers to enable access to payment systems and to manage conflicts relatingto vertical integration.Launching investigations in response to consumer complaints or super-complaints from marketparticipants or industry bodies.Conducting wider market conduct and function reviews.Undertaking further action pursuant to ensuring that the regulatory objectives are met.

9. REGULATED E-MONEY AND UNREGULATED EMERGINGPAYMENTS

The initial objectives, scope and purpose of the PSR are highly commendable. However, the initial policyproposals also leave significant room for further actions that are required for the PSR to enable aproperly functioning and innovative payments sector.

Within new areas of regulated payments innovation such as the EU regime for issuing electronic money(a continuing and increasingly obvious misnomer given the rise of virtual currencies), the UK under the

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Financial Services Authority took the lead as the most supportive, pragmatic and adaptable regulatoryenvironment. This regulatory stance has often been necessary to encourage operators to takeadvantage of the European Union’s intention to encourage alternative payment providers under the e-money directives and the Payment Services Directive (which also need to be consolidated). In manycases, other EU member states have not been so encouraging and difficulties with understanding theunderlying EU law relating to, for example, what is “e-money” and what are “payment accounts”, inaddition to difficulties in accessing payment systems and making use of passporting permissions, havemeant that the sector requires a constructive and supportive regulator.

In addition to the PSR’s UK macro-regulatory position it will be interesting to see the extent to which itwill become involved in working with the FCA on significant cross-border legal and regulatoryuncertainties. Cross-border trade issues are macro-issues. The PSR’s relationship with the EuropeanBanking Authority and regulators in other jurisdictions will, therefore, be crucial to achieve macro-levelobjectives. There is also real need for a payment specialist regulator within the EU to take up thechallenge of being a European advocate for emerging payments with member states and to help theEuropean Commission, Parliament and Council to structure payments laws and processes that meetstated objectives, are technologically neutral and take account of emerging innovations.

There is also the need for the PSR to look at and identify the opportunities and risks relating to newcurrently unregulated payment networks and currencies. These new providers and solutions allowtransfers of value using non-fiat currencies (known as virtual or crypto-currencies) and will often alsoinvolve mediation between virtual and fiat currencies. In fact, reviewing and pioneering the regulation ofvirtual currencies and encouraging their use and acceptance might lead to quicker and easier results tomeet many of the PSR objectives than expending all its effort and time to try to move the attitudes ofmajor market counterparties who will be loathe and slow to change their complex and establishedsystems and processes.

Currently, the UK, and most of the EU, takes the view that virtual currencies do not constitute fundsunder either the Payment Services Directive or the Electronic Money Directive, and to date they arelargely unregulated. However, given that the meaning of money ultimately derives from its acceptanceand use it is only a matter of time before such virtual currencies are deemed to be recognised forms ofmoney that require regulatory oversight and supervision. Someone somewhere has to take the lead onthis issue to help these innovations flourish while protecting consumers from security breaches, fraud,pyramid sales schemes, insolvency, etc. The smart players in the virtual currency sector are also lookingfor such a regulatory home.

The introduction of a PSR puts the UK in a good position to maintain its place as the preferred EUjurisdiction for payments companies. However, given the interconnected and technology driven world,the next phase must include widening the PSR’s initial scope. This widening of scope will befundamentally necessary for the PSR to meets its objectives of a healthy, open, innovative andcompetitive market for all payments.

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Geography:

10. AUTHOR'S DETAILS

Rampart's founder Peter Howitt has been at the forefrontof the innovative and rapidly expanding area of e-commerce and financial law since 2000. Peter workedin-house as Company Secretary and General Counsel at Transact, a European licensed e-moneyprovider, advising on legal, corporate, commercial, tax and regulatory issues. Since then Peter has beendeeply involved in the development of regulated e-commerce sectors, including online gaming andfinance in the UK, EU and Gibraltar.

In 2012 Peter founded Ramparts European Law Firm, which provides bespoke support for multi-nationalcompanies in the financial services (e-money, finance and funds), electronic commerce (includingpayments and e-gambling) and technology sectors. He is also the co-founder and Secretary of theGibraltar E-Money Association (GEMA), which focuses on identifying and promoting the commoninterests of locally authorised international payment service providers (the prepaid and e-paymentssector). Peter continues to contribute to the development of e-commerce law through publications andadvising clients on EU wide regulatory issues. He is also engaged in newer developments in crypto-currencies and P2P lending and investment.

UNITED KINGDOM

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Sectors:

Content:

Spotlight Subject:

PAYMENT PROCESSING PAYMENT SYSTEMS

EXPERT COMMENTARY

THE UK'S PAYMENT SYSTEMS REGULATOR

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