IPS 2014 Roundup

IPS 2014 Roundup
So you’ll have gathered from recent blog posts that it’s conference season. This is the first of a few posts rounding up some of my recent events. This post is about International Payments Summit (IPS) which took place last month. Jacob mentioned in his Finovate post that he ensures that he attends as many sessions as possible – IPS is very much turning into my equivalent. I wrote last year about my return to the event after a long absence. This year didn’t disappoint either. For me, there is a great mixture of depth but also variety, with many speakers I’d not seen before. It’s not a cheap show, but content wise, worthwhile. If I had to make some suggestions, I’d suggest perhaps fewer 20min presentations. Whilst I can think of one speaker where that was probably 18m too long, there were some others who deserved longer. Lots of notes and things to follow-up on, but two themes really stood out. 1)      Innovation. Some great presentations, some challenging ideas. For me, the most provocative was from Mark Stevenson, of Flow Associates. The famous baseball player Yogi Berra once famously said “The future ain’t what it used to be”. Mark left me feeling somewhat like that! I can’t do his presentation justice here, but from the advent of cheap solar power to impact of 3D printers, the picture of the world that Mark painted was necessarily, radically different than the world of today. But effectively the punch line to the presentation was that this future was not 50 years away, but only 5. Scary, scary thoughts ensued as we thought this through! 2)      Regulation. The second day of the conference fell the night after the second draft of the PSD2 was voted upon in Brussels. The speaker had attended the session, and then hot-footed it to London – content can’t get much fresher! But across the conference, there were some very deep, technical discussions, which even I struggled with at times. Regulation seems to be getting ever more complex and specialised. The conference closed with the panel that I sat on, where we summarised the key points of the conference. My take away was labelled “Mind the gap”. I was particularly struck about how little overlap there was between the innovation and regulation discussions, and noticeably, how they were moving further apart. It would seem, considering the sheer volume of regulation that banks face, an obvious place for innovation to take place.

The Most Important Three Little Words in Payments?

The Most Important Three Little Words in Payments?
No, not “I Love You” or “Buy Celent Research”. But That, Which and May. The long running saga around Durbin interchange fees took another twist last week. To recap, a group of merchants (knowns as NACS) sued the Federal Reserve, arguing that the Durbin rule it had imposed exceeded the authority granted by Congress to the Federal Reserve. To many peoples surprise, in July 2013, U.S. District Judge Richard Leon upheld that opinion and ruled that the Federal Reserve did not comply with the Durbin. The opinion was generally harsh on the Fed, with the judge writing: “The court concludes that the [Federal Reserve] Board has clearly disregarded Congress’ statutory intent by inappropriately inflating all debit-card transaction fees by billions of dollars.” The judge also ruled that the Federal Reserve failed to ensure that merchants enjoy access to “multiple unaffiliated networks” to process each debit-card transaction, as also required by the Durbin Amendment. In short, the judge ruled that the Fed needed to re-write the Durbin amendment. In January 2014 the case went to the US Court of Appeals, with literally billions of dollars at stake. Last Friday, March 21, saw the panel overturn the initial ruling, and the Durbin Amendment stands. This is a significant victory for the Fed and the banking industry, and major blow for the retailers. So why the title of this blog? In their decision, the judges severely criticised the quality of the drafting of the report. In particular, the use of the word “which” instead of “that” became central to the decision. That’s two of our three words. It reminds me of the issues in implementing the Payment Services Directive in Europe. The PSD was published in French, German and English. Understandably, the numbers of words varied between documents. But oddly, so did the numbers of paragraphs. That was the first issue – a belief that not everybody was working to the same document. With English the business language of many of the international banks, and English being spoken more widely than the other two languages, more countries used the English version as their starting point. And that’s where the trouble began. The word “may” was used widely throughout the document – over 200 times. The nuances of English language education meant that some read the word as permissible; some read it as optional; whilst other again assumed it meant they had to. A simple word, but very important differences in understanding. The consequence is that the next draft of the PSD is trying to address issues that it never assumed would be issues! Three simple words which (that?!) most of us probably never think about yet had billions of dollars in implications!

Much Ado About Nothing

Much Ado About Nothing
Today the European Commission released its long awaited study into the cost of merchants accepting cash and card payments. A copy of the preliminary presentation can be found here. It’s long awaited for a number of reasons. Firstly, it is supposed to finally address the issue of comparing actual costs. Whilst there have been many studies in the past that looked at this, nearly all had a flaw. Those commissioned by one of the interested parties had such inherent biases that it rendered them almost unusable. For example, the anti-cards lobby conveniently chose to inhabit a magic kingdom where labour was free and cash magically appeared and disappeared from stores, free of charge!  Academic studies have typically been too academic – lots of interesting formulae, but not grounded in reality. The Commission set out, once and for all, to get a definitive answer. That’s the second reason why it is important. The Commission has taken what many believe as an “anti-card” stance, with a view that cards are unnecessarily expensive. At the same time, they are actively promoting electronic payments as paper/cash is costly and inefficient, but not taking into account some fundamental differences, such as cards are a commercial business, whilst cash is supplied in essence by the State (I know, I know – that sentence is a whole debate in itself!). The study then was supposed to create an unambiguous fact-base. The more cynical of us has wondered what happens if the study presents data that is contrary to the stance of the Commission, and that could contradict the last decade of activity from the Commission in this area! The programme has not been without it’s problems. A previous study commissioned a few years ago has never been released, and has been perceived as not reaching the answer the Commission wanted. This is primarily because the consultancy selected is highly regarded for their integrity and knowledge – by not sharing anything about the study, the market has reached it’s own conclusions. In the introduction to the document today though was a comment that it had “Unsatisfactory methodological recommendations.” Secondly, the request for a subsequent study was woefully underfunded. Unsurprisingly, the target number of merchants to study was not met by a considerable margin. This isn’t to criticize the firm that won the tender, more that the opportunity to do this right was never there. Alot of preamble – what did we learn? Not much. I wasn’t able to attend the presentation, so there is – literally – only the afore mentioned deck to study. For me the initial take-aways are:
  • The fact that no clear conclusions could be reached yet, and that the sample size achieved was only 50% of the initial target highlights, either just how hard this is to do and/or, actually it’s much closer than they thought. For example, if one payment type had substantially more costly than another it’d surely have been highlighted
  • The low response rate and the bias to large merchants is likely to leave the survey open to criticism
  • More detail is required to give comfort – for example, the cost seems to suggest some significant missing costs (such as CIT fees, bank cash handling fees, etc)
The net result is that we’ve not really any clearer, and we’re left wondering why they didn’t wait until they had reached some conclusions. Whilst we don’t have the commentary given during the presentation, the fact that the event and presentation didn’t even warrant its own press release suggests that not much was said. And so we’re left still in the dark, and probably, on balance, even less optimistic that we’ll get the answer that we all seek. Much ado about nothing!

Saddling up the hobby horse again

Saddling up the hobby horse again
Wednesday saw the Government announce  ) its plans to overhaul UK payments. Regular readers of the Celent blog will know I’ve commented on this several times – here, here, and here. In short, the Government asked the industry, in a poorly formulated consultation, whether it wanted to be regulated or not; unsurprisingly, the industry said no. The Government then launched a second consultation, and asked the industry whether a) it wanted to be regulated or b) whether it wanted to be regulated. As one response said “….we believe the aims of Government in the current consultation are weakly defined, naive and rather generic.” And that from a non-bank and who would potentially benefit from the changes! It came as no surprise then that the Wednesday that the Government has chosen to regulate the industry. Coverage in the press has been less than helpful. One small bank was quoted in The Times as saying that they had to pay 40p for a Faster Payments whilst the big banks got them for free, and that was symptomatic of the issue. Indeed, that comment is symptomatic, being incorrect, illogical and unhelpful. The big banks do pay for every transaction, also paid large amounts of money (>£200m) collectively to create the system, and the small bank would be most welcome to join the scheme, and pay lower transaction fees (albeit accompanied by large running costs for the system!) Previously, I challenged the Treasury to come up with some clear objectives, with transparent ways of measuring success in achieving those objectives. These still don’t exist – indeed, in the release they use a bizarre example from Sweden which isn’t even successful in Sweden as justification. I think therefore we need to start from even further back. Firstly, let’s get our facts right. Get an independent auditor to level set the assumptions and data they’ll be building from. Secondly, let’s be clear of the purpose. Much of what the regulator is proposing will have no positive effect for the consumer, and likely a negative one, as ultimately someone has to pay for these changes, and it’ll be customers. Thirdly, use the correct analogy. A utilities regulator assumes it’s a utility, but payments isn’t and never has been. The payment system is a private enterprise, run by a group of banks, for a group of banks. Could we imagine the local corner shop trying to force Tesco to let use its online shopping site to sell its goods? No, but that’s essentially what the regulator is trying to do here. The regulator will never succeed unless it’s sets off on the right foot, and in the right direction. There is little evidence of that so far.  

Thoughts on the Move to Regulate UK Payments

Thoughts on the Move to Regulate UK Payments
In a blog on February 5th we broke the news that there was likely to be a regulatory review of payments governance. This was as a result of a speech the chancellor had made the previous day. Whilst UK centric in topic, these changes have global implications, as more governments around the world take an interest in payments, and many regulations have followed at least the principles initiated in Europe and/or the UK. Various aspects of Durbin and Dodd-Frank are examples, such as 1073 and interchange intervention. At the time I questioned the need for such a review. The previous consultation “Setting the Strategy for UK Payments”  had been due to report months earlier. Our understanding is that the Treasury feels that the responses (56 in total) gave the wrong answer. Which considering the construct of the consultation (it was extremely clear what answer the Treasury was seeking) would seem a rather clear conclusion – few people are both interested enough to respond and believe that there is a need for fundamental change. Yet the Treasury has taken this as further indications that the system is broken, and announced yesterday during the Budget (an annual statement of the Governments’ policies and priorities for the coming year) that a consultation on a PayCom will go ahead shortly. Our understanding that this will take place in a very short period of time, possibly by the end of March. An edited version of the statement follows, but the full statement can be found on p49 of this document

 Competition in the banking sector

1.157 …..The Government demonstrated this commitment by asking the Independent Commission on Banking (ICB) to consider competition as part of its remit. Having accepted the competition recommendations of the ICB in full, the Government is currently delivering an extensive programme of reform. ……:

that the Government will shortly issue a consultation document on bringing payment systems into a competition-focused regulatory regime. The regulator will have strong powers to ensure that challenger banks have the opportunity to compete on a level playing field with their larger competitors by requiring that challengers can access the payments infrastructure fairly and transparently. Subject to the outcome of the consultation, the Government intends to legislate for the new regime in the Financial Services (Banking Reform) Bill;

  Some points to note. The first statement is misleading. Whilst it did accept the recommendations in full, the Treasury also seems to be including things that weren’t recommended – the ICB report clearly states that did not find evidence that access to the payment systems was a barrier to entry, nor did the report recommend a PayCom – the emphasis below are mine, not the reports:

“In its interim report, the ICB raised possible concerns about the ability of small banks to access the payment systems. It said there was some evidence to suggest that the ability of banks to access the payment systems through incumbents, and the ability of the Payments Council to maintain a level playing field in payments, were not conducive to a competitive market.

However, the evidence was not clear-cut, and this was not raised as a substantial barrier by most new entrants. Therefore, the ICB did not make recommendations in this area, beyond suggesting that the Bank of England, in collaboration with the FCA and OFT, should monitor  access to the payment systems and the effectiveness of the Payments Council in providing adequate governance to ensure innovation and competition.

The Government believes that more needs to be done to bring the Payments Council within the scope of financial regulation, taking into account the relationship between the Payments Council, its members and inter-bank payment systems. The Government is therefore developing a number of options for potential reforms. HM Treasury will publish a consultation on the options, including options for creating a new regulatory structure for the Payments Council and the inter-bank payments regime, taking into account the need to preserve the stability and integrity of payment systems; enhance open competition by reducing barriers to entry; promote innovation; and reflect the needs of end users, as well as the needs of payment service providers.

The consultation will take place early in 2012.”

The ICB was very clear – it was the Government not they who believe that the Payments Council should be brought into the scope of regulation. And during my time working for one of the UK payment schemes, we had more enquiries about leaving the scheme, than joining (2 versus 1 if memory serves correct). So what does this mean? I am not suggesting a review is a bad thing, nor even that PayCom itself is a bad thing. Unless the industry reflects on what it does well and what it doesn’t well, it cannot ensure that it fixes what needs fixing and preserve what doesn’t. And that’s my fundamental issue. The Government has prescribed the medicine, ignoring the advice of the specialist it had appointed (i.e. the ICB, the Cruickshank report, the OFT and it’s latest consultation), and is about to forcibly administer it yet has neither articulated the diagnosis nor listened to the symptoms. PayCom cannot ever succeed unless it is clear what it is trying to achieve, why it seeks to achieve those goals, and what the measures of success are. We can only hope that the forthcoming consultation provides some reassurance.  

Ensuring Competition in Payments

Ensuring Competition in Payments
Last Friday, the European Commission announced that it has extended its investigation into Project Oscar, the proposed mobile payments joint venture from a group of UK telcos. The regulator is concerned that the venture could be anti-competitive. Project Oscar is a JV between Vodafone, Telefonica and EverythingEverywhere (Orange and T-Mobile) to develop an infrastructure which would enable mobile payments as well as other mobile services, such as couponing, loyalty, etc. As required, they submitted their plans to the EC for approval last month and after the inital review period ended, the Commission decided to extend its investigation for another 90 working days. This week I received a lot of enquiries about what this means. Does this kill mobile payments in the UK before they even take off? Will this have implications for other similar JVs? Indeed, a similar partnership in The Netherlands known as Sixpack also had to delay their launch plans as they went to seek the EC approval. And in a different area of payments, I heard that the interoperability pilot between the three existing OBeP schemes (EPS, iDEAL and Giropay) is also being stopped by the European Commission investigation into allegations of anti-competitive behaviour by the European Payments Council, which commissioned the pilot. However, I wouldn’t read too much into this at this stage. To me, the latest UK announcement simply implies that:
  • Payments regulation is complex and there are many issues to consider when approving new entities, especially in new and unfamiliar territories, such as mobile infrastructure;
  • The regulator is not willing to make rushed decisions and is prepared to take an in-depth look at the new venture;
  • Three, another UK telco, has likely done a good job at raising their concerns about being excluded from this partnership so far.
My view is that all the regulators around the world should keep in mind three primary objectives of payments regulation:
  1. Protecting the parties conducting a payment transaction, i.e. consumer and merchant protection;
  2. Fostering competition and ensuring a level playing field among payment service providers;
  3. Managing systemic risk and ensuring security, soundness and stability of the overall economy.
By taking its time to review the proposals, the regulator is only fulfilling its obligation around the objective #2. Lets wait and see what the decision is at the end of August.

“Should We Repel Durbin?”

“Should We Repel Durbin?”
That was the question someone asked me last week at an ATM, Debit and Prepaid Forum. I know – it was in Vegas, the person was joking and the question is really a rethorical one. And yet, it kind of rings true, because no one seems to be happy with the new regulation. Except, of course, the lobbyists, lawyers and other industry advisors. And perhaps some acquirers and ISOs. As expected, “Life after Durbin” discussions dominated the event. Of course, the large debit issuers are unhappy – the general consensus is that this will wipe out about $8bn in annual interchange revenue for the industry. The issuers are looking for ways to cut costs or to raise revenue. It was interesting to watch how nearly everyone had to update their slides, as Bank of America withdrew their planned $5 debit card fee about 24 hours before the official conference started. The bank itself explained that they “listened to the customer feedback and acted accordingly.” The smaller exempt issuers are not entirely unhappy. Credit unions announced a large new customer intake (“760k new accounts in the last 10 days, more than in the entire year previously”). However, they are worried that they will also feel competitive pressure on interchange or might be discriminated by the merchants and their acquirers. Also, it remains to be seen how profitable the new customers will be for them. Prepaid issuers seem to be unsure what to make of it. On one hand, some prepaid cards are exempt from regulation, however, the exemption conditions and small print gets very complex very quickly. Cue in the lawyers and corporate counsels to help navigate the regulatory maze. The network routing rules banning the exclusivity arrangements are seen as an opportunity by at least some of the networks, especially the smaller ones. However, the implementation – renegotiation of contracts, setting up of routing rules, etc – is not an insignificant undertaking for all involved. Cue in consultants and more lawyers. Perhaps most surprisingly, the merchants are not happy at all. The merchant panel, represented by senior executives from Walmart, 7-Eleven and McDonald’s was one of the most interesting sessions at the Forum. They all expressed disappointment in the final regulation. Walmart said that the regulation was a “disappointment, but a good start for future regulatory reforms, including credit.” It is true that for small ticket purchases, the costs of debit acceptance have gone up, as it’s now a flat fee, i.e. the cap was implemented also as a floor. When asked if and when consumers can expect to see lower prices, the merchants responded by saying that the “merchant market is very competitive, therefore any cost changes will be passed to consumers, both increases and decreases”. In other words, “expect prices not to change much or perhaps even go up.” Redbox, a US-based DVD rental firm, already followed through on this and raised its prices for DVD rentals from $1 to $1.20 quoting increases in their costs of debit processing. Smaller merchants are also unhappy because it might take time for any savings to trickle through to them. Unless their acquirers and processors charge them “interchange plus”, they may find it difficult to demand immediate reductions in their bundled fees. Those with lower volumes may also lack the necessary know-how or may simply prefer avoiding the hassle of putting pressure on their acquirers to lower their fees. It will take a better part of next year for the full effects of Durbin regulations to become clearer, but the early signs are that it won’t reach all of its intended outcomes. So, what’s next? P.S. As an aside, this year’s ATM, Debit and Prepaid Forum saw the best-ever attendance – over 1,100 participants – and had a very interesting agenda with great speakers. Congratulations and thank you to SourceMedia, the event organisers, and Tony Hayes, a conference chairman (and a partner at Oliver Wyman, Celent’s parent company) for all their efforts!

The Unintended Consequences of Regulation

The Unintended Consequences of Regulation
Last week I attended Celent’s Innovation and Insight Day in Atlanta and had an opportunity to catch up with many of our clients, both banks and technology vendors. One of the banks told me an interesting story how after Reg E came into force, they saw a drop in debit card usage and a significantly increased demand for cash. As many of you know, Reg E requires a customer to opt-in to an overdraft facility for debit transactions at the point-of-sale. The regulation’s intention was good – to protect consumers from unexpected overdraft charges. However, the outcome was an unintended steer back towards cash at the point of sale. Many consumers didn’t understand the requirement to opt-in and having had their card declined at the POS due to insufficient funds in their current account, lost confidence in shopping with the debit card. If there is no easy way to check balance and there is a risk that the transaction might be declined, then it is easier just to withdraw cash and use that for purchases instead. As a result, the bank is faced with an unexpected increase in costs and efforts to forecast cash demand and replenishing ATM’s in time to meet that demand. According to a meeting notice published on its website, the Fed plans to meet on June 29 to discuss “Debit Card Interchange Fees, the Fraud Prevention Adjustment, Routing and Exclusivity Restrictions and related matters”. As the Durbin saga is nearing conclusion with the final rules expected to be announced after the meeting, there is a risk that this regulation will also have far-reaching and unintended consequences. Celent has just re-published an Oliver Wyman article series called “Durbin Second-Order Effects“. Oliver Wyman’s partner Andrew Dresner and the series’ author argues that by reshuffling the relative costs between debit, credit and alternative payments, Durbin will have as profound an impact on other actors in the payments ecosystem as it does on debit issuers. Do you agree? Do you have other examples of unintended consequences of regulation?

Responses to Reg E

Responses to Reg E
In the Celent report Reg, Reg, Go Away: Sorry Banks, They’re Here to Stay, I laid out a stark landscape for checking accounts due to the implications of Reg E. Revenue will drop and profits will drop likely moving into loss. What should banks do? A few of the options were:
  • Raise price
  • Create bare bones accounts
  • Create bundles
  • Reduce cost
Bank of America has a clear strategy. They have indicated that they will not go on an opt-in campaign for one time debit and ATM transactions. This is in great contrast to JP Morgan Chase who is aggressively pursuing opt-in. Bank of America is pursuing a number of other strategies. One, laid out in the report is a small business bundle: “Bank of America’s Small Business Checking Bundle includes a Business Checking Account, a personal checking account for the business owner, and no cost so long as the customer uses his Visa debit card once a month.” And now American Banker reports that they are working on developing a bare bones account with fees for value added services. They just introduced a fee for printed statements for certain accounts in Georgia, clearly a trial for larger geographies. Reg E is a game changer in retail banking and banks need to come up with some proactive response, as Bank of America and JP Morgan Chase are doing. What is your bank doing?

Credit Card Legislation

Credit Card Legislation
Large credit card issuers have been given relatively free rein in the past. That has now come to an end with recent legislation. Double cycle billing is now over. According to the American Banker, “The statute allows card companies to increase rates on existing balances only when a payment is 60 days or more late, a promotional rate expires, the rate is tied to a variable rate or the cardholder has entered a workout agreement.” While I can understand how card holders are upset if they find their rates increased unilaterally, it also prohibits banks from repricing for risk when the financial circumstances of the card holder change. I can think of a reasonable compromise: a happy medium would be to allow limited rate increases on existing balances (say x% every 3 months) given certain well-defined changes such as a drop in FICO score of greater than y. This is unsecured credit, and if risk increases so should price. Mortgages, car loans, and HELOCs have a collateral to help banks recover some of their loans in worst case. Credit cards don’t, so I think banks deserve A BIT, more flexibility. Credit cards shouldn’t give banks carte blanche to double cycle bill, apply payments to the advantage of the bank, repeatedly charge overlimit fees for the same event. Look for similar Congressional action on NSF fees tied to debit cards. With the government bailing out the banks, citizens are feeling empowered to question some of the more egregious practices.