Much is written about revolutionary developments in payments, but the reality of progress in such a complex area is that it is often evolutionary. Legislators, regulators, and industry have been working incrementally to streamline the movement of money with the potential for profound effects beginning to emerge. We discuss below key European and U.S. Open Banking developments, advances in domestic and international payments infrastructures, and potential opportunities for payments firms in this area.
Open Banking – Europe
Regulatory innovation in the UK and the EU has fostered the development of the payment ecosystem in Europe. The first Payment Services Directive (PSD), which came into force in December 2007, was a legal framework for a single payments market across the EU. Between September 2019 and December 2020, the second Payment Services Directive (PSD2) came into effect, bringing with it new regulation of Account Information Service (AIS) and Payment Initiation Service (PIS), and enabling new opportunities for value creation in financial data and payments.
More recently, the European Commission has been conducting consultations on the effectiveness of PSD2.1 We expect the resulting reforms (PSD3) to include PSD2 being merged with the Electronic Money Directive and efforts to remove obstacles to the provision of AIS and PIS. We also expect legislative change to seek to reduce the exclusion of payments and e-money institutions from the banking system by banks (so-called “de-risking”), and to encourage a move to Open Finance that would enable third-party access to savings, investments, and insurance data in a similar way to how Open Banking has operated in relation to payments accounts.
Meanwhile, the UK government has opened a review of the UK payments regime.2 The review considers, among other things, potentially updating the safeguarding regime that applies to client funds in payment services, moving to an “outcomes-based” approach to regulation requiring firms to implement Strong Customer Authentication for certain transactions, and adopting a risk-based approach to the settlement of transactions, which could permit payments firms to settle transactions later than T+1 in certain circumstances.
If enacted, PSD3 and the potential UK reforms could provide welcome regulatory flexibility for European payments firms. They may, however, also represent divergence from previously common UK-EU standards that could introduce operational and regulatory complexity for firms in both the UK and the EU markets. Divergence could also threaten the UK’s continued participation in the Single Euro Payments Area (SEPA), which currently permits cross-border Euro clearing from the UK. Market participants and their advisors will be watching this space closely.
Open Banking – U.S.
Unlike the UK and the EU, there is currently no harmonized legal framework for non-bank payments across the U.S. Open Banking-type initiatives in the U.S. tend to be industry-led, and it is not always straightforward for customers to share their financial data with third parties. However, legislative and regulatory changes that would establish a comparable Open Banking framework are under development.
The legal basis for these changes goes back to the 2010 Dodd-Frank Act, which required banks to make financial data available to their customers and for the Consumer Financial Protection Bureau (CFPB) to make rules permitting this. For various reasons, those rules have not yet been made. However, following the inclusion of Open Banking as a policy priority in an executive order that President Biden signed in July 2021, the CFPB has been working on new rules that would facilitate Open Banking-type services in the U.S.
The new rules would require financial institutions that offer deposit accounts, virtual wallets, credit cards, and other payment accounts to share account data on the customer’s request—a move designed to enable customers more easily to switch account providers and to increase competition in the market. We expect that the new regulations could come into effect from as early as next year.
The potential U.S. payments regime under the CFPB’s new rules would have similarities to other major Open Banking markets such as the UK and the EU. It could be combined with similar Open Banking initiatives in other regions such as Singapore where service providers may operate under a major payment institutions licence granted under the Payment Services Act 2019 that provides powers comparable to that of PSD institutions in the UK and the EU.
Advances in Payments Infrastructures
There have been many recent domestic and international initiatives to improve payment infrastructure, including the development of rapid payments systems. In 2008, the UK launched Faster Payments, a real-time payment system capable of facilitating rapid inter-bank payments of up to £250,000 in value. In 2017, the SEPA Instant Credit Transfer Scheme, which permits near-instantaneous Euro payments of up to €100,000 24/7/365, came into operation. The U.S. is developing a similar instant payment service, FedNow, which is anticipated to go live in July. Other jurisdictions have also successfully launched rapid payment systems, such as Brazil (Pix) and India (UPI).
The proliferation of domestic instant payment networks and their rapid user growth leads to a natural extension: cross-border instant payments via inter-operability of domestic networks. A recent exciting development in this theme is the successful conclusion of an initiative to design a scheme for the cross border inter-operability of domestic payment networks by the Bank for International Settlement (BIS) – Nexus.3 The project connected the Eurosystem’s TARGET International Payment Settlement system, Malaysia’s Real-time Retail Payments Platform, and Singapore’s Fast and Secure Transfers payment system.
In its report on Nexus,4 BIS sets out what it regards as the key principles for a future Nexus scheme for cross-border instant payments. BIS highlights the challenges of an international inter-operability project in financial services and proposes a number of potential solutions, including the use of proxies for account data, the use of ISO 20022 message standardization and a flexible cloud-based/on premises architecture. The report also notes that it will be necessary to navigate the tension between financial crime and data protection rules for such a scheme to function with minimum friction and thus deliver the same experience that users enjoy at a domestic level.
The BIS’ report identifies the following key Nexus service providers: 1) IPS operators – operators of domestic instant payment schemes (IPS) that would be direct participants in the Nexus scheme; 2) Payment Service Providers – bank and non-bank payment service providers to payers/payees that are eligible to connect to IPS; 3) FX Providers; and 4) Settlement Account Providers – to provide accounts for FX settlement where an FX provider does not have a direct connection to a relevant IPS. The Nexus scheme would be designed so that separate service providers could fulfil the roles of Payment Services Provider, FX Provider, and Settlement Account Provider, but would also permit service providers to fulfil multiple functions.
In terms of next steps, the BIS plans to collaborate with the central banks of Indonesia, Malaysia, the Philippines, Singapore, and Thailand as they take steps to connect their domestic IPS. The BIS will also seek input on the development of Nexus beyond the Southeast Asia region from central banks and payment system operators from major instant payment markets through a Global Advisory Panel. We expect further interesting developments in this internationally significant project.
Opportunities for Payments Firms
The advances in regulatory frameworks and payment infrastructure directly benefit consumers and businesses by improving access to cash flow at a lower cost with greater certainty, as the IPS generally provide continuous real-time settlement and finality of payments. This potentially reduces the need for short term credit at both the user and institutional levels and generally contributes to the market demand for better, faster, and cheaper payments solutions.
These developments also generate significant opportunities for payments firms. Service providers that can access multiple payments infrastructures, preferably on a direct basis (as may e-money and payment institutions in relation to Faster Payments, for example), can pass on those benefits to their customers either domestically or internationally if they are connected to multiple currency clearing systems reducing cost, accelerating settlement times and providing users with richer data regarding those payments. As firms begin to harness the potential for cross-border payments via inter-operable IPS, we believe the opportunities for value creation will abound with ample room for both private and public solutions to co-exist.
For more information about any of the developments discussed in this alert, please contact Wilson Sonsini attorneys Josh Kaplan and Chris Hurn.
[1] https://ec.europa.eu/info/law/better-regulation/have-your-say/initiatives/13331-Payment-services-review-of-EU-rules/public-consultation_en.
[2] https://www.gov.uk/government/consultations/payment-services-regulations-review-and-call-for-evidence.
[3] The BIS also has projects under way studying the potential benefits of central bank digital currencies, which in time may provide superior alternatives to globally connected domestic instant payment networks.
[4] BIS, Project Nexus, Enabling Instant Cross-Border Payments, Conclusions from a technical proof of concept between the Eurosystem, Malaysia and Singapore, March 2023; https://www.bis.org/publ/othp62.pdf.