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  1. Analysis
May 18, 2007

The PSD: the devil is in the detail

While the European Parliaments vote in favour of the Payment Services Directive has been widely applauded, there are obstacles to successful implementation that may have considerable implications for the cards industry On 24 April 2007, after protracted negotiations and compromises among the main stakeholders, the European Parliament voted in favour of adopting the Payment Services Directive (PSD), the legal framework underpinning the Single Euro Payments Area (SEPA) initiative

By Verdict Staff

While the European Parliament’s vote in favour of the Payment Services Directive has been widely applauded, there are obstacles to successful implementation that may have considerable implications for the cards industry. Francesco Burelli* presents an overview of the challenges.

On 24 April 2007, after protracted negotiations and compromises among the main stakeholders, the European Parliament voted in favour of adopting the Payment Services Directive (PSD), the legal framework underpinning the Single Euro Payments Area (SEPA) initiative. The PSD is the key step in the establishment of a common legal framework for payments across the European Union (EU), and creates the basis for a more consistent industry outlook within Europe as it also covers non-EU countries.

The law introduces the concept of the payment institution, a new type of entity that will be able to operate payments, and, in so doing, will potentially enable non-banks to access the payment infrastructure and to expand their businesses into the provision of payment services; they may then compete directly with banks across Europe or disintermediate the banks by accessing the payment infrastructure directly.

On the road to SEPA

The PSD has been welcomed as a step towards the implementation of SEPA and, more broadly, towards achieving the objectives of the Lisbon Agenda (an action and development plan for the EU set out in Lisbon in March 2000).

However, there has also been criticism, as the implementation of the PSD poses considerable challenges to the payment industry. For example, the European Savings Bank Group has taken quite a critical position towards the PSD, particularly regarding the introduction of the payment institution and its regulatory requirements, as, in its view, it could threaten both public confidence in the PSD and its implementation timeline.

The PSD, which consists of over 120 pages and 87 articles, will require the EU member states to interpret it and translate it into domestic law by 1 November 2009. Even though the PSD is in principle what it terms a “maximum harmonisation directive” – meaning that the member states may not go beyond the requirements of the directive in national implementation – many important issues such as surcharging and setting of tighter capital requirements than those specified in the PSD are still left to the discretion of member states to resolve during the implementation stage. There are many other points that may be subject to even more discretionary interpretation.

The full impact of the PSD on the cards industry has not yet been fully realised and much will depend on how the PSD is translated into domestic law. The entry of non-banking organisations and the effect of the new provisions on existing agreements, fees, charges, clearing and other operational aspects bear close examination.

Payment institutions are non-banking organisations that will be able to have access to the payment infrastructure and to operate payments directly without the need for a banking intermediary. In the cards industry, non-banks could apply for their own issuing and acquiring licences and, potentially, could become direct competitors to the established issuers and merchant acquirers.

The constraint on the maximum volume of payment transactions is such that it is unlikely that any of the major processing organisations will ever be in the position of applying for its own licence and disintermediating its clients. It is, however, likely that major merchant organisations will consider it as an opportunity for reducing their cost of card payments acceptance.

Once non-banking organisations have payment institution licences, the implications for the card payments industry could be significant. For processors, it is likely to mean more potential clients for their services. For bank issuers and acquirers, the implications could be not just seeing clients turning into competitors, but the opportunity to offer white label issuing and acquiring services.

It is unlikely that a non-banking organisation will be able or interested in entering the issuing or acquiring business on their own, as they lack required core skills. For banks, this will present an opportunity that will see them competing with processors and that will require a significant shift from the traditional issuing and acquiring business models.

Redrafting of agreements

The PSD will require the redrafting of cardholder and merchant agreements in order to comply with a number of requirements. The PSD requirements in terms of transaction authorisation, communication and claims mean that the topics of refunds, transaction disputes and type and timing of transaction confirmation to be provided to the payer (cardholder) and payee (merchant) will require the redrafting of contracts and agreements in order to reach compliance.

In many cases, substantial changes will be required to include information about the payment services provider, use of payment services, charges, interest and exchange rates, terms of communication, safeguards and corrective measures, changes and termination of framework contact and contract duration.

While all these points are typically already included in the standard agreements in use, the PSD sets out additional details and formats for the inclusion of such information under Title III. Articles 27 and 28 define the specific information to be made available to the payer and the payee after the receipt of the payment order and after execution, respectively. For example, subject to the interpretation of each individual member country, the PSD requirement for “immediate” information provision could result in the need to provide a set of information to the cardholder and merchant on an almost real-time basis, rather than the current time-delay system.

Depending on the interpretation of Articles 27 and 28, there could be significant implications for the cards payment industry, as issuers would have to find ways to provide cardholders with information immediately after the receipt of the payment order (or, in the case of a card payment, upon the receipt of the authorisation request).

Industry consultancy Capco has carried out impact assessment projects with a number of merchant acquirers. On the basis of its finding, Capco believes the implementation of the requirements included in Article 28 will pose quite a challenge, and will not be workable in all cases on the basis of the current infrastructure. As the member states translate this provision into domestic law, there will be implications at infrastructure and operational level for card payments.

Fees, charges and clearing

The PSD indicates that the sharing of charges between a payer and a payee is the most efficient system to facilitate the straight-through processing of payments. While on the one hand the PSD allows fees to be levied on the payer, it also states that this provision does not affect practices wherein the payment service provider does not charge the consumer for crediting their accounts. It also states that the fee may take the form of an annual fee.

All this does not imply any changes to the current practices within the European cards industry; however, the PSD also states in another article that the payment services provider should not prevent the payee from requesting a fee from the payer for using a specific payment product. This will allow merchants to surcharge cardholders for a card payment in those countries where the national government has not decided against this in their translation of the PSD into domestic laws.

Title IV, section 2, 60 has significant implications, particularly for merchant acquiring, as it states that a payment should be cleared into the payee accounts within one day from transaction date. Leaving aside the impracticability of implementation on the basis of the current infrastructure, given that an overnight batch process would enable a merchant acquirer to issue a payment order to the merchant account only on the day following the transaction, this would require at least an additional day for the funds to reach the account and be available to the merchant. Moreover, if this were the case, there would be significant additional funding costs for the merchant acquirer, given the cycle time of clearing a transaction through the payment scheme’s network.

For those merchant acquirers that are managing credit risk in a proactive manner, it means that they would not be in a position to manage credit risks through delayed settlement and that they would be left with only the lever of collateral deposits from the merchant, insurance or third-party guarantees to mitigate credit risk. It remains to be seen how merchants will lobby individual governments in order to obtain a more favourable domestic interpretation and translation of the PSD into law.

The PSD has succeeded in achieving a good degree of political compromise around a number of critical issues. The exemptions for small e-money networks and the capital requirements set for a payment institution are tougher than those included in the initial drafts. While the UK was hoping for more liberal rules, countries such as France and Italy have been pushing for more restrictive requirements as a way to protect the banking system from potential new competitors or, if looked at from a different perspective, to protect and to ensure the reliability of public confidence in the payment industry.

All in all, it is doubtful that the PSD will meet its goals in full as there will be differences in the way countries will interpret it and finalise it into law. This will likely lead to a situation in which some countries may offer more favourable regulatory requirements for different players within the value chain.

*Francesco Burelli is principal consultant at Capco and may be contacted at francesco.burelli@capco.com

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