This article first appeared in September’s issue of the E-Finance & Payments Law & Policy journal.
The UK’s Payment Systems Regulator (PSR) uses market reviews and market studies as the principal way in which it investigates how well the market for payment systems is working for those who use payment services. The PSR has carried out and reported on a number of reviews since its
launch. In this article, Sadie Alo, Zoë Hare and Kate Johnson focus on two recent reviews, being:
- the review into the supply of indirect access to payment systems (the supply of indirect access review); and
- the review into the ownership and competitiveness of infrastructure provision (the ownership and competitiveness review).
The PSR believes that addressing issues in these areas will drive competition and innovation in the payments industry, ultimately benefiting the consumers of payment services. Sadie, Zoë and Kate discuss the PSR’s findings in these two reviews and the likely implications for the payments industry.
The supply of indirect access review
Why indirect access?
The PSR believes that access to payment systems is a key driver for competition and innovation in the provision of payment services, and that this in turn enhances the services made available to customers of payment service providers (PSPs). A PSP has indirect access to a payment system if it has a contractual arrangement, or sponsor service, with another PSP, an indirect access provider (IAP), to enable it to provide payment services to its own customers (i.e. transferring funds using that payment system). In this article, we refer to such PSPs as ‘indirect PSPs’.
The four main banks which provide indirect access to other banks, credit unions and PSPs are Barclays, HSBC, Lloyds and RBS. For many PSPs, or potential PSPs, indirect access provides an important, and sometimes the sole, route to accessing payment systems. The PSR’s review focused on indirect access of PSPs to the main interbank payment systems in the UK, namely, Bacs, CHAPS, Cheque and Credit and Faster Payments Service (FPS), which access allows those PSPs to transfer funds for their customers.
In launching the review, the PSR’s aim was to look into whether competition was working well for PSPs, for instance, in terms of choice and their ability to switch from one IAP to another and the fees charged.
According to the PSR, some banks and PSPs had raised concerns relating to the limited choice of IAPs and a lack of information about the indirect access services that the IAPs offered. The review focused on the following four key questions:
- What prices, service and choice do indirect PSPs want and receive?
- What factors may limit the number of IAPs in the market?
- What is the state of competition in the provision of indirect access?
- What options are there to improve indirect access to interbank payment systems?
Following a period of gathering evidence and information from stakeholders, analysis and an interim report published in March 2016, the PSR published its final report setting out its final findings in May 2016.
In its final report, the PSR confirmed its interim findings that while competition in the supply of indirect access was producing some good outcomes for indirect PSPs, there were concerns about choice, service quality and the ability of indirect PSPs to switch providers. In particular, market conditions were less favourable for non-agency and smaller PSPs and it remained a concern whether the technical solutions provided to indirect PSP’s met customer needs.
The PSR’s concerns can be broadly summarised as follows:
- Choice: while the larger PSPs tend to have access to a good range of payment systems, smaller PSPs have more limited choice and, as a result, have less scope to negotiate on price.
- Ability to switch: the limited choice available for some PSPs restricts their ability to switch providers if they are not satisfied with the service they are receiving.
- Service quality: concerns raised by large and medium agency PSPs (particularly banks and building societies) about the quality of technical access to FPS, and by small non-agency PSPs regarding notice periods for the termination of indirect access agreements and the relationship management provided by IAPs.
The nature and extent of the PSR’s specific concerns differed among small, medium and large indirect PSPs, but there were three market characteristics at the root of these concerns:
- Industry responses to financial crime regulation. A perceived risk of compliance failures under financial crime regulation influences the behaviour of IAPs, which could be limiting the provision of indirect access for some indirect PSPs.
- Lack of entry of IAPs. Entry and expansion of new suppliers of indirect access has been low, which limits the competitive pressure on IAPs to improve their indirect access proposition and limits the choice available.
- Increase in demand for real‑time payments. The growing demand for real‑time services has brought into question whether the technical solutions provided to indirect PSPs still meet customer needs.
The PSR concluded that on-going evolution of the industry had the potential to address these issues, highlighting some recent and anticipated developments as examples, including:
- various on-going reviews of financial crime legislation aimed at improving the transparency, clarity and effectiveness of the UK’s anti-money laundering and counter terrorist financing regime;
- the potential entry of four new IAPs to the market and existing providers broadening their offerings;
- the development of the Image Clearing System for cheques;
- various measures introduced by the PSR to enable PSPs to have direct access to the interbank payment systems, which should in turn increase the number of indirect access providers;
- the publication of the Code of Conduct for IAPs published by Payments UK. The Code sets out standards of best practice for commercial arrangements between IAPs and PSPs. Currently, four IAPs have subscribed to the Code, namely: Barclays, HSBC, Lloyds Banking Group and RBS;
- information‑related initiatives, such as the PSR’s Sponsor Bank Information Direction; and
- the Payments Strategy Forum’s work, for example, on examining whether and how payment systems can be developed to simplify access.
The PSR reported that these developments will be monitored over the coming months and an update on progress will be delivered in early 2017. An overview of developments in indirect access will also be incorporated into the PSR’s annual review of access and governance of payment systems, which will likely be published in early 2017.
The ownership and competitiveness review
What does the PSR mean by payment infrastructure?
The PSR launched its market review into the ownership and competitiveness of infrastructure provision in March 2015, following responses to its consultation paper on the regulatory framework for payment systems which highlighted concerns with the common ownership of operators and the infrastructure provider.
Payment systems infrastructure comprises “the hardware, software, secure telecommunications network and the operating environments that supports the clearing and/or settlement of a payment”.
Currently, a small number of banks jointly own the Bacs, FPS and LINK payment systems as well as the infrastructure for those systems (i.e. VocaLink). Whilst the PSR acknowledged that this may have helped contribute to keep costs down and develop payment systems that are relatively robust and resilient, it wanted to carry out the review in order to investigate whether payments infrastructure works in the interests of users of the payment systems and to consider whether or not current infrastructure ownership arrangements and market structure restricted competition or innovation.
During its review, the PSR gathered evidence from more than 70 stakeholders, including PSPs, infrastructure providers, operators, and FinTech companies.
The evidence gathered during the PSR’s market review pointed to issues in the market which gave rise to competition concerns. The PSR considered that there was scope to improve competition in the provision of infrastructure services through a number of proposals for reform.
- Divestment of shareholding in VocaLink: The PSR concluded that the common ownership of VocaLink by a small number of banks is adversely
affecting innovation and competition in the market. The PSR proposed that to remedy its concerns Lloyds Banking Group, RBS, HSBC, Barclays and Santander should sell part of their ownership stakes in VocaLink. The PSR considered that reducing the level of their ownership will open the market
and enable more effective competition and innovation.
- Competitive procurement process: The PSR also concluded that the procurement of payment infrastructure services may prevent potential providers from competing effectively. As such, the PSR proposed introducing a new open, transparent, competitive procurement tendering process for the provision of infrastructure services, which is independently audited and monitored.
- Common messaging standard: The PSR decided that the current unique messaging standard acts as a barrier to entry for new infrastructure providers in the UK and that a common standard would create a level playing field. The PSR therefore proposed that a common messaging standard be introduced in the market in respect of communications between Bacs, FPS and LINK, and the infrastructure provider.
- Separation of LINK from VocaLink: The PSR found that LINK and VocaLink are not separate legal entities and that the current governance and
contractual arrangements for LINK services (including the fact that the contract for services is between VocaLink and all 38 PSPs in LINK) makes
it difficult to switch provider. The PSR therefore proposed a number of measures to separate common ownership functions of LINK from VocaLink, so that “the body responsible for setting the rules for the payment system and awarding the contract is functionally and legally separate from the infrastructure provider that delivers these services”.
The PSR believes that these proposals will drive competition and innovation, and create opportunities for new entrants to come into the market.
Implication and reactions
Whilst the PSR decided not to take any immediate action or make any recommendations following the supply of indirect access review, this has not been the case for the ownership and competitiveness review. In particular, the PSR’s conclusion in the latter review that the banks should reduce their stake in VocaLink, in order to open the market and allow more effective competition and innovation, elicited much reaction from industry players.
In the UK, VocaLink processes over 90% of salaries, more than 70% of household bills and almost all state benefits. The PSR’s view appears to be that this is too much control in too few hands. Whilst being very firm in its recommendation that stakes in VocaLink be sold, the PSR appears to believe that its role stops there. It has not made recommendations as to the levels that need to be sold off, or to whom. On the subsequent news that MasterCard is to acquire VocaLink (MasterCard has entered into a definitive agreement to purchase 92.4% of VocaLink), the PSR commented that it would be for the relevant merger authority to consider the effects of this merger under merger control law. Adding […that discussions are taking place about ownership, and changes being made, is an encouraging sign that people are starting to question the status quo and ask whether it offers effective competition.”
Some industry commentators have not been so restrained about their views on the proposed acquisition. Concerns that have been raised by such commentators have included the following:
- Concerns that MasterCard has been challenged previously in relation to pricing and that giving a monopolistic position to such an organisation, (MasterCard currently faces significant damages claims from customers in respect of its multilateral interchange fees), does not give comfort that there will not be a dramatic increase in charges.
- Concerns that selling Faster Payments to MasterCard will kill off what many believe is due to be one of the most important innovations to come out of the UK payments industry in recent times: the Faster Payments New Access Model for real time 24/7 payments. Commentators believe that this innovative payments proposition will be a direct threat to one of MasterCard’s core products and MasterCard may have a vested interest in stifling it.
- Some question how single ownership of VocaLink can improve competition and open up access to payments infrastructure. Views have been expressed that the perceived negative effects of the current 18 bank consortium ownership (largely, lack of innovation) is much more preferable to the potential monopolistic practices and exploitation that may result from one player having a controlling interest over the entire infrastructure.
- Many question the PSR’s view that the current ownership structure has led to a lack of innovation, citing that the UK payments system is one of the most innovative in the world. Questions have been raised as to whether a corporation like MasterCard would be similarly able, or, more importantly, inclined, to drive innovation.
It is clear from the above views that, at the very least, the PSR’s review process has encouraged discussion on whether or not the status quo in the payments industry is working for all users. Whilst the PSR takes a collaborative approach by consulting with industry players in its market reviews and making recommendations, it has warned that where evidence shows the payment systems industry is failing to deliver greater competition, more innovation and greater benefits for businesses or consumers, then it will not hesitate to act. It remains to be seen whether any acquisition by MasterCard will deliver such benefits. The PSR will be keeping an eye on proceedings.