Regulating Digital Payment Services: Considerations for Canadian Policymakers | Dentons
Advances in contactless payment technology like tap to pay debit cards and Apple Pay have increased consumer demand for cashless payment methods. This demand has been amplified by the COVID-19 pandemic, as individuals have become uncomfortable with cash and online shopping has replaced physical activity (we discuss these trends in a four part series).
As consumers move away from cash and switch to digital payment methods, the market for non-bank payment service providers (NBPSP) is growing. In Canada, NBPSPs have remained largely unregulated, and the growing number of NBPSPs providing banking-like services will require lawmakers to create an appropriate regulatory regime. While the government introduced the Retail Payment Activities Act (discussed here), many regulatory details still need to be clarified.
In July 2021, the Bank for International Settlements (BIS) published: “Fintech and payments: regulating digital payment services and electronic money. “The authors discuss how NBPSPs are regulated around the world, using data from a 2021 study of 75 jurisdictions. This article highlights the different regulatory regimes and may help guide Canadian policymakers in the process. ‘development of the regulatory framework for digital payment services.
What are NBPSP?
According to the BIS, NBPSPs use the existing payment infrastructure, or their own stand-alone systems, to deliver new payment methods and services to consumers. NBPSPs can be classified into two overlapping subcategories. First, those that offer value storage in an account or device, for example, products offered by companies like PayPal. Second, those that rely on the storage of value by another institution, for example, merchants and co-branded prepaid cards.
NBSAPs typically provide one or more of the following services:
- Provision of transaction accounts
- Provision of electronic money transaction accounts
- Provision of e-wallet services
- Issuance of payment instruments
- Acquisition of payment transactions
- Money or value transfer services
- Virtual asset services
- Electronic funds processing / value transfer for third parties
- Payment initiation services
- Account Information Services
What is electronic money?
Among the services provided by NBPSPs, the issuance of electronic money is subject to the most stringent regulations among the jurisdictions studied. Interestingly, the concept of electronic money is not recognized from a regulatory perspective in Canada, where terms like “virtual currency”, “cryptocurrency”, “virtual assets”, “digital money” and “electronic money” tend to be used interchangeably. As described by the BIS, electronic money is a debt-like instrument issued when receiving funds for the purpose of facilitating payments. To be considered electronic money, the instrument must:
- Serve as a versatile medium of exchange (i.e. the instrument can be used more widely than something like a prepaid gift card);
- Be accepted as a means of payment by third parties other than the issuer; and
- Be issued only upon receipt of funds (i.e. be prepaid).
The regulatory landscape
I. License and registration
Some jurisdictions have general licensing frameworks for all payment services, while others distinguish between them, for example, licensing requirements may differ for an e-money issuer and an e-money service provider. virtual assets. Additionally, some jurisdictions have separate licensing requirements based on transaction values. For example, in Japan, payment service providers are ranked based on the maximum value of the transaction they can execute. Another basis on which jurisdictions distinguish licensing requirements is the geographic area covered by the service. For example, the licensing of remittances in the United States is done primarily at the state level.
In almost all jurisdictions where non-banks are permitted to issue electronic money, there are licensing models specific to electronic money, namely the narrow banking model and the non-banking model. In the narrow banking model, non-banks can apply for a limited banking license that allows them to offer a limited set of banking services. In this model, approved institutions are governed by banking law and are therefore subject to stricter rules than traditional issuers of electronic money. According to the BIS, in practice these licenses are underutilized in jurisdictions where they are available, possibly due to the heavy regulatory burden imposed by banking law. In the non-bank model, specific types of non-banks are allowed to issue electronic money, for example, electronic money institutions, issuers of prepaid instruments or issuers of stored securities.
II. Minimum capital
In most jurisdictions, NBPSPs have initial and ongoing capital requirements. Typically, the initial capital requirements are fixed and vary depending on the payment volume authorized under the license. Alternatively, the capital requirements of some jurisdictions are based on the location of NBPSPs or the type of service they provide. Regarding the permanent capital requirements for issuers of electronic money, they are usually set as a percentage (usually 2-5%) of the free float of the electronic money.
III. Ensure the security of funds
The safeguard requirements aim to ensure that e-money holders can exchange their e-money at face value. This can be achieved by requiring NBPSPs to reserve assets in a commercial bank, central bank or to invest funds in high quality liquid assets. Safeguarding of funds is required in almost all jurisdictions where non-banks are permitted to issue electronic money and in most jurisdictions where non-banks are permitted to provide transaction accounts.
In some jurisdictions, protected deposits are held in trust or in an escrow account so that client funds are segregated from those of the electronic money issuer and cannot be claimed by creditors in bankruptcy. In other jurisdictions, this segregation of funds is not required; instead, issuers of electronic money are required to obtain insurance. While some jurisdictions allow electronic money issuers to choose any backup method, others require a specific one.
Interoperability is the ability of systems and software to exchange information. The pursuit of interoperability aims to increase efficiency and strengthen competition in the payments market. Interoperability is the least common regulatory requirement among jurisdictions. In addition, its application varies considerably according to the types of payment services. For example, in some jurisdictions, issuing electronic money requires interoperability between issuers where virtual asset services do not. Other jurisdictions have plans underway to achieve interoperability. The EU has adopted a new retail payment strategy with the aim that future retail payment systems will be pan-European and feature end-to-end interoperability.
V. Fight against money laundering / terrorist financing (AML / CFT)
AML / CFT requirements are the most common in the jurisdictions studied. Since NBPSPs are not subject to the same level of supervision as banks, they are considered to present higher AML / CFT risks. Typically, AML / CFT requirements include the implementation of Know Your Customer (KYC) and Customer Due Diligence (CDD) standards. Some jurisdictions apply a tiered approach to KYC and CDD, where small transactions have lighter regulatory requirements. A few jurisdictions go further by fully exempting certain low-risk, low-value transactions from AML / CFT requirements.
VI. Consumer protection
Some jurisdictions have consumer protection laws that are specific to the financial industry or even specific to different types of payment services. Consumer protection in the context of NBPSP focuses primarily on transparency and disclosure of information as well as handling customer complaints and preventing fraud.
Disclosure of information is especially important when it comes to transaction fees for money transfers. Many jurisdictions require service providers to disclose the fees charged for a transaction as well as the foreign exchange margin for cross-border payments. The importance of fee disclosure has been underscored in the United Nations 2030 Agenda for Sustainable Development in the context of reducing transaction costs for migrant remittances. In Canada, a consumer protection framework applicable to NBPSPs will need to be developed to ensure that consumers receive adequate protection when using new payment methods or technologies.
With growing consumer demand and private sector competition in the digital payment services space, Canadian policymakers will need to strike a balance between protecting consumers and promoting innovation and industry growth.
Special thanks to Caroline Harrell (intern) for her help with this article.