What to expect in 2023: Payments and the Financial Sector
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Introduction
Over the last few years fintech and the regulation around payments has evolved rapidly to keep up with new technology. Recent crisis has impacted how we consume and pay and now we can see a desire from regulators to future proof regulation to resolve barriers to consumer protection which have been emphasised by new technology developments and societal changes.
We think the key themes emerging are about encouraging innovation from new and existing firms as well as protecting customers from a rapidly changing environment in which they access payment services.
On reflection in 2022 we saw EU regulators putting in the groundwork to reform yet again the regulation of payment services, such as the targeted consultations of the review of the revised EU Payment Services Directive 2015/2366, an Open Finance framework and the announcement of Instant payments. In the UK we have seen focus on moving forward with a regulatory framework for stablecoins to create a flexible framework for future technology changes and to safeguard against systemic risks to the financial system. Separately we have seen a push from the UK FCA to set higher standards for the culture and conduct of firms for better customer protection via the Consumer Duty.
2023 is an exciting year for payments full of new opportunities and challenges. Although there will be a lot of change, we’ve have narrowed down what we view are the top three topics for this year:
- Alternative payments: Stable Coins, Digital Euro, BNPL
- Review of PSD2 through proposals in respect of PSD3
- Open Banking and Open Finance
1.Alternative payments: Stable Coins, CBDCs, BNPL
Stablecoins
This year we expect that regulatory updates will continue to ensure the right conditions for issuers and service providers will enable consumers to confidently use stablecoins as a method of payment.
According to data from the European Central Bank, stablecoins account for a fragment of the crypto-asset market but are a critical part of the ecosystem, “Although their market capitalisation increased from €23 billion in early 2021 to just under €150 billion in the first quarter of 2022, stablecoins still only account for below 10% of the total crypto-asset market”[1]. Due to rapid growth of the market regulation is needed to foster innovation. Global trends around the regulation of stablecoins indicate that stablecoins have the potential to develop into a widespread means of payment.
The EU Markets in Crypto-asset Regulation (MiCA) will ensure stablecoins are subject to the same minimum requirements, irrespective of licensing regime and will address any potential systemic risk to financial stability from “significant stablecoins”. MiCA is anticipated to be set down in the Official Journal of the EU in April this year.
The UK Government (the Government) acknowledge that international coordination for the stablecoin and crypto asset market is needed and that the UK framework for stablecoins needs to be flexible enough to respond to innovation. According to the UK document, “Approach to Cryptoassets, Stablecoins and DLT in Financial Markets”[2], there is a general agreement that a UK systemically important stablecoin should also be subject to the Bank of England Regulation and we look forward to seeing a consultation from the Bank of England later this year. On 1 February, the UK Government published proposals on its overarching approach to implementing a financial services regime for regulated activities in respect of crypto-assets and we cover this in a separate insight. On the same day, the Government also published its consultation response in relation to financial promotions relating to fungible crypto-assets.
Amendments to the Financial Services and Markets Bill currently in passage in Parliament broadens the remit of legislation to include promotions of all crypto assets. To support this initiative the FCA are also consulting on a Financial Promotions Approval Gateway which would require approving firms of financial promotions for unauthorised firms to apply for permission.
Digital Euro
The Digital Euro project for the Eurozone through the European Central Bank has been undergoing a prototyping exercise feeding back findings to industry. The Digital Euro will complement the use of cash and would provide a means of payment for anyone in the euro area.
The “investigation” phase of the digital euro appears to be making swift progress. Work on a digital euro rule book commenced in January this year and we expect to see what regulation of a digital Euro could look like when the European Commission propose a bill in Q2 of 2023.
Buy Now Pay Later
The UK will be one of the first countries to regulate BNPL lenders. On 20 June 2022 the Government published its response to a consultation on BNPL regulation conducted between October 2021 and January 2022.
The need to regulate has primarily been driven by the Woolard review in 2019, however the pandemic has since expedited the growth of BNPL services, with users being of a younger demographic with social media playing an important role in the increased usage of BNPL. The response document sets out the Government’s view of what a “proportionate regulatory regime”[3] for BNPL products. We expect to see regulation on the following:
- Short term interest free credit provided by third parties.
- Obligation for BNPL providers to undertake credit checks before providing the service.
- An exemption for BNPL where the deposit is paid, and the balance is paid in a single payment.
- Give customers the ability to make a complaint to the Financial Ombudsman.
We expect to see new BNPL regulation in the UK by mid-2023. It will be interesting to see how merchants are impacted by the reforms and whether they fall outside of the regulatory perimeter when introducing their customers to BNPL lenders, for example in relation to the regulated activity of credit broking.
The EU have also reached a provisional agreement on the revision of the Consumer Credit Directive. The new directive modernises rules around consumer credit agreements that exist today such as loans below €200, loans offered through crowdfunding platforms and ‘buy-now-pay-later’ (BNPL) products. The agreement on changes to the Consumer Credit Directive are now subject to approval from the Council and European Parliament.
2. Review of PSD2- the PSD3
The PSD2 often presented as a gamechanger for financial services introduced Open Banking which has been a success, according to latest figures from the UK Competition and Markets, Open Banking has over 6 million active users in the UK.
The European Commission announced the review of the PSD2 in its Retail Payments Strategy in September 2020. The review is likely to address gaps or clarifications and challenges which need to be addressed, which could possibly include PSD2 API obstacles also highlighted by the European Third Party Providers Association[4].
In a call for advice from the European Commission on the review of the Payment Services Directive[5], the EBA proposed many improvements for addressing these gaps. Additional recommendations could also come from the payments industry through the May 2022 Targeted Consultation on “Open Finance framework and data sharing in the financial sector”. While it’s difficult to assume what the new PSD3 framework may address/introduce at this stage, a number have recommendations have been made.
The EBA identified areas for improvement through a peer review on authorisation under PSD2[6] and have made recommendations to the European Commission as part of the PSD2 review, the following: “the delineation between the different categories of payment services and e-money issuance, the applicable governance arrangements for institutions, including the criteria that competent authorities should use in assessing the suitability of management, and what having sufficient local substance requires” .
It is also likely that the review of PSD2 will also consider the impacts or opportunities for the Open Finance Framework, which is being considered in Parallel.
- merging the PSD2 and the Electronic Money Directive 2;
- clarifying the application of strong customer authentication (SCA) and the transactions in scope;
- addressing new security risks for customers such as social engineering fraud where customers are tricked into initiating a payment transaction;
- addressing concerns about authentication approaches (e.g. based on smartphones) that have led to exclusion of certain groups of society from using payment services online;
- addressing underlying issues and obstacles to the provision of payment initiation services (PIS) and account information services (AIS), including the proposals for (i) AIS providers to apply their own SCA with their customers instead of relying on the authentication procedures by banks, (ii) empower customers to remain in control of their data; and (iii) support the development of high-quality interfaces across the EU;
- moving from 'Open banking’ to ‘Open finance’ (or otherwise the expansion from access to payment accounts data towards access to other types of financial data) and the opportunities and potential challenges associated with it, based on the PSD2 experience – more on that below;
- addressing the enforcement shortcomings in relation to the implementation and application of SCA for e-commerce card-based transactions and the removal of obstacles to the provision of AIS and PIS;
- addressing unwarranted de-risking practices by banks affecting payment and e-money institutions; and
- adjusting the prudential requirements, in particular in relation to initial capital, own funds, the use of professional indemnity insurance, the proposal for recovery and wind-down for significant payment institutions and possible consolidation group supervision”.
According to the European Work Programme for 2023, the Commission will aim to publish a draft of proposals by Q2 of 2023. The next step will be for the EU co-legislators to examine and amend the draft text before formal adoption.
The UK Treasury’s recent publication of the review and Call for Evidence on the Payment Service Regulation sets out Government objectives for achieving a future proof and tailored approach for the UK market following the UKs exit from the EU.
Alongside the review and Call for Evidence the Treasury have also published a Post Implementation review of the Payment Card Interchange Fee Regulations 2015 (PCIFRS), the Interchange Fee Regulation 2015 (IFR) which is EU derived regulations which caps interchanges fees received by debit and credit card issuers. The IFR will be repealed and replaced by a Financial Service and Markets Act (FSMA) model in due course. The Financial Services and Markets Bill is currently making its way through Parliamentary stages.
The UK’s existing framework is based on retained EU law, the PSD2, the Government review is seeking evidence on the Electronic Money Regulations 2011 and Cross Border Payment Regulations while working to address existing gaps. The following objectives have been outlined for the review:
- Achieving agile and proportionate regulation, which facilitates the international competitiveness of the UK economy through growth and innovation in the UK payments sector
- Ensuring appropriate trust and protection for consumers
- Ensuring the resilience and integrity of the UK‘s payment market
- Fostering competition, in the interests of consumers
The Government is determined to ensure new regulation is agile and future proofed and will consider the balance between delegation to the FCA and requirements in statute, noting a strong case of delegation to the FCA for firm-facing rules, this new approach is expected to enable to FCA to react quicker to regulating on new types of service/technology.
More detail around the review and Call for evidence can be found here.
3. Open Banking and Open Finance
The European Commission will continue to work to expand the benefits of Open Banking to sharing access and reuse of personal and non-personal data for the purposes of wider financial services. Further steps to enhance data openness across sectors will create opportunities for customers and data driven innovation. According to a report from the Expert group on the European financial data space[7], a core focus of open finance should be “to improve financial products and services and to create opportunities for consumer and firms to obtain better targeted advice and personalised services. This includes:
- Customer experience – a broader choice for customers and easier identification of the best options through access to a more tailored and personalised range of services and products; as well as an easier ability to access and use those products;
- Financial inclusion - improving access and use of financial services for all segments of consumers and firms, including SMEs and access for financially excluded people;
- Customer control - giving customers meaningful control over how their data is shared and reused, in line with data protection rules; providing consumers and firms with greater transparency about how their data is used and accessed;
- Innovation - facilitating the interoperability of data in open finance; as well as supporting the development of Artificial Intelligence / Machine Learning models to build services and products for consumers and firms including more accurate prudential risk management.
- Horizontal approach – embed the open finance approach of customer-centric services in a general cross-sectoral framework” .
The European Commission are expected to publish a framework for Open Finance in Q2 of 2023.
The UK Government have expressed a desire to foster competition in the interest of consumers through its review and Call for Evidence on the Payment Services Regulation 2017. Unlocking Open Banking payments is a critical area for delivering on the Government’s vision for the payment sector the FCA, PSR, and HM Treasury (the Treasury) are developing a long-term regulatory framework for Open Banking in the UK. In addition, the Treasury, CMA, FCA and PSR who form the Joint Regulatory Oversight Committee is expected to produce a final report in Q1 2023 for the next phase of Open Banking.
Conclusion
2022 was a year of consultations and laying down the groundwork for regulation, 2023 will move us forward to seeing plans set down to encourage the growth of payments and innovation in the EU such as the PSD3 and plans for Open Finance.
In addition, regulators in particular the UK, are conscious of falling behind the curve of new emerging services like stablecoins and BNPL where the most suitable frameworks have been restrictive to regulating the services/products thus far. However, with the Government’s objectives in motion for a more agile framework, a new wave of payment services may encounter a better equipped UK regulator if the FCA firm-facing approach to regulating is successful.
Our Payment Services Regulatory team will be monitoring next steps and shall keep you up-to-speed with the latest developments.
Co-authors:
Scott McInnes, Finance & Financial Regulation Partner, Belgium, [email protected]
Gavin Punia, Finance & Financial Regulation Partner, London, [email protected]
Trystan Tether, Finance & Financial Regulation Partner, London, [email protected]
Melissa Daley, Knowledge Manager, London, [email protected]
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[1] Stablecoins’ role in crypto and beyond: functions, risks and policy (europa.eu)
[2] O-S_Stablecoins_consultation_response.pdf (publishing.service.gov.uk)
[3] BNPL_consultation_response__Formatted_.pdf (publishing.service.gov.uk)
[4] European Third Party Providers Association - PSD2 Obstacles (etppa.org)
