Key changes to European e-money legislation have recently been introduced in the form of a new e-money directive. The new directive follows a review by the European Commission of the original e-money directive, which found that e-money has yet to deliver its anticipated benefits.
In addition to highlighting the key regulatory changes introduced by the new directive, this article considers the factors behind the success of e-money in Japan, and questions whether the new directive will act as the catalyst for similar growth in the European e-money market.
Whilst the new directive removes a number of regulatory barriers to issuing e-money, we conclude that significant investment in technologies and infrastructure, combined with supplier collaboration to develop attractive and innovative services for consumers, will be essential for the successful growth of e-money in Europe.
Background
On 27 July 2009, the Council of the European Union adopted a new directive on electronic money (the new EMD).[1] The new EMD followed an extensive review and consultation by the European Commission to evaluate the original electronic money directive (the original EMD), adopted in 2000.[2] The Commission review identified a number of deficiencies in the original EMD, many of which arose from ‘the difficulty to foresee at the time how the business of e-money issuance would evolve’.[3] As a result, flexibility is a prominent theme for the new EMD.
The new EMD abolishes the original EMD and introduces amendments to the Money Laundering and Banking Consolidation directives.[4] In the UK, the Financial Services Authority will run a consultation on the implementation of the new EMD this year, prior to the new EMD becoming law on 1 May 2011.
The new legislation is intended to encourage growth in the European market by addressing concerns about the scope and applicability of e-money legislation, and is expected to achieve a better balance between a prudential regulatory regime and actual risks faced by electronic money issuers (ELMIs).
Key features of new EMD include a revised definition of e-money, removal of the restriction on issuers conducting mixed business, more flexible initial and ongoing capital requirements for ELMIs, simplified criteria for waivers from authorisation, clarification of redeemability requirements, and some relaxation of anti-money laundering requirements.
Key Changes
Definition of e-money
The new EMD simplifies the definition of e-money by removing references to defined storage mediums (specifically ‘chip card or computer memory’). This renders the definition more technology-neutral, catering for server-based e-money solutions used in the online retail sector, such as PayPal. The new definition also includes magnetically (as well as electronically) stored monetary values, which could extend e-money technologies to include magnetic (non-smart) cards and disposable medium produced by existing magnetic ticketing infrastructures.
Payment transactions are now defined with reference to the Payment Services Directive (PSD),[5] a step towards the expected harmonisation of EMD legislation with the PSD,[6] which may simplify the future transition of ELMIs to full credit institution status. The new definition continues to exclude e-money issued for free, by retaining the stipulation that e-money must be issued ‘on receipt of funds’ and accepted by a person ‘other than the e-money issuer’.[7] ‘Limited networks’ also remain excluded.[8]
Mixed business
The original EMD limited ELMIs to engaging in business activities closely related to the lending of e-money. Article 6 of the new EMD dissolves this restriction by permitting ELMIs to conduct business activities in addition to issuing e-money (having regard to other applicable European and national legislation). The scope of payment services that ELMIs are permitted to provide are also widened to include the payment services listed in the Annex to the PSD.[9]
The removal of these restrictions is expected to reduce costs significantly for new participants entering the market by allowing them to issue e-money alongside their core business activities. This may encourage e-money issuers engaged in other types of business activities, such as transport operators, mobile operators and retailers, to launch new services in the payments market.
Initial capital requirements
The Commission review concluded that the initial capital requirements for issuing e-money under the original EMD were excessive and disproportionate to the risks posed by issuing e-money. The Commission considered that such a high level of initial capital has been the principle obstacle to the establishment of smaller ELMIs and prevented waived institutions from ‘upgrading’ to full ELMI status.
Article 4 of the new EMD addresses the issue by reducing the initial capital requirements from EUR 1,000,000 to EUR 350,000. This measure is further expected to encourage new ELMIs to enter the market and will assist waived institutions in migrating to full ELMI status.
Ongoing capital requirements
Article 8 of the PSD sets out three methods for calculating issuers’ ongoing capital requirements, based on fixed overheads; payment volume; and interest income. Article 5(3) of the new EMD introduces a fourth method based on floats.
The new formula is based on payment volumes equivalent to 2% of the average outstanding e-money. This simplified method is designed specifically for ELMIs and is restricted to ELMI activities related to the issuing of e-money. For other ancillary activities, one of the three PSD methods must continue to be used, as determined by the relevant competent authority (for example, the FSA in the UK).
Waivers from authorisation
The success of the waiver scheme under the original EMD has undoubtedly facilitated the present growth of the e-money market, enabling innovation to be tested in the marketplace by businesses that would otherwise have been unable to attain ELMI status.
Article 9 of the new EMD supports this growth by simplifying the eligibility criteria for a waiver to be granted by the relevant competent authority. Issuers now need to ensure total outstanding e-money does not exceed EUR 5,000,000, and that the persons responsible for the issuer have not been convicted of offences relating to money laundering, terrorist financing or other financial crimes.
These changes are likely to reduce administration costs and may encourage more pilot schemes to appear as businesses and other organisations face fewer barriers to offering e-money services.
Redemption fees
The original EMD required ELMIs to allow e-money holders to redeem e-money at par value, in cash or by credit transfer, free of all charges except those strictly necessary to process the redemption. ELMIs could specify a minimum threshold for redemption in contracts with e-money holders, provided the threshold did not exceed EUR 10.
In its consultation paper on the new EMD, the UK Treasury acknowledged the Commission’s conclusions that the redeemability requirements of the existing EMD presented problems for mobile network operators (MNOs) (to the extent that their activities fell within the scope of the legislation), as MNOs’ business models are unable to split out pre-paid funds for mobile services from e-money funds (for payments for third party goods and services). [10]
Recital 6 of the new EMD clarifies the status of MNOs’ existing business models by confirming that the Directive does not apply:
‘where a mobile phone or other digital network subscriber pays the network operator directly and there is neither a direct relationship nor a direct debtor-creditor relationship between the network subscriber and any third party supplier of goods or services […]’.
However, some tension remains between the redeemability requirements of the new EMD and future business models that could be adopted by MNOs. Article 11 of the new EMD retains the right for consumers to redeem e-money at par value at all times and free of charge, although issuers are permitted to charge a fee for redemption commensurate to the actual costs incurred by the issuer if specified in the contract between the e-money holder and the issuer in circumstances where:
§ redemption is requested before the termination of the contract;
§ the contract provides for a termination date and the e-money holder terminates the contract before that date; or
§ redemption is requested more than one year after termination of the contract.
In its response to the UK Treasury’s consultation on the new EMD, the Mobile Broadband Group (MBG)[11] noted that one potential route for e-money development would be for MNOs to implement a hybrid business model which allowed pre-paid airtime to be used in payment for third party goods and services, including making direct payments to third party suppliers.[12] However, the MBG expressed concern that the new redeemability requirements ‘could be interpreted as an obligation to redeem all funds held on mobile pre-paid accounts with an e-money functionality’, which could prove to be a barrier to the development of hybrid solutions – indeed the MBG commented that ‘if the Commission wishes to see the e-money market develop, removing the “redeemable for cash” requirement is essential’ in this context to promote uptake within the mobile community.
Whilst the Commission has already noted that MNOs would like new specific exemptions from redeemability requirements to be introduced to facilitate the payment services that MNOs offer their customers,[13] there is as yet no specific legislative proposal to deal with the issues identified by the MBG. This is likely to be a key issue for the Commission to revisit when reviewing the implementation of the new EMD.
Anti-money laundering compliance
As part of the adoption of a more proportionate, risk-based regulatory framework, the new EMD makes changes to the threshold values for compliance with anti-money laundering and anti-terrorist financing purposes. Article 19(2) of the new EMD amends Article 11(5)(d) of the Money Laundering Directive to increase the maximum storage value of non-rechargeable devices (ie those that cannot be topped up) from EUR 150 to EUR 250.[14] The limit on the total amount transacted within a calendar year for rechargeable devices (that can be topped up) remains at EUR 2,500, except in instances where amounts of EUR 1,000 or more are redeemed within a calendar year.
Commercial Consequences
The new EMD provides an improved legislative foundation upon which e-money services can be built, however significant commercial commitment and consumer buy-in will be essential to the successful growth of e-money. A better understanding of the success factors underpinning e-money can be gained by considering an already flourishing example: Japan.
The success of e-money in Japan
The success of e-money in the Japanese market can be largely attributed to the technology platform on which e-money is issued and accessed. The Japanese market uses a contactless radio-frequency identification (RFID) card called FeliCa. The technology was developed by a subsidiary of Sony and NTT DoCoMo (a leading MNO in Japan). The same technology powers the Octopus Card, a successful smartcard ticketing system used by the Hong Kong mass transit system.
In July 2004, NTT DoCoMo launched a mobile contact payment system utilising mobile FeliCa, an adaptation of the existing technology for the mobile market. According to a recent Forrester report, the number of FeliCa enabled handsets reached 3 million within 6 months, 14 million by the end of 2006, and a total of 30 million a year later. By the end of 2008, market coverage had reached an estimated 55 million handsets (over 50% of the Japanese market) of which 12% used their phones to make electronic payments.[15] To achieve the necessary market growth, NTT DoCoMo licensed mobile FeliCa to rival operators during 2005, this ensured the necessary penetration and the establishment of a de facto standard throughout the marketplace.
Despite the success within the mobile phone market, FeliCa claims the most popular use of the technology to be an electronic purse service named Edy, which can be used in 80,000 shops and has 43 million card holders, of which 8 million utilise the technology through their mobile phone. Second to Edy is Mobile Suica, an e-ticketing system that can be used on the Japanese Railways East networks, and has 26 million card holders of which 1 million use it via their mobile phones.
The success of FeliCa in Japan is considered to have resulted from:
§ Collaboration – the licensing of FeliCa technology to ensure compatibility between services and operators, and the subsequent collaboration between operators and manufacturers on handset development.
§ Investment – the creation by FeliCa of integrated turnkey solutions along with investment equivalent to EUR 40,000,000 to ensure that retailers had the technology to read mobile devices.
§ Regulation- the relaxation of financial rules in Japan that enabled non-banks to provide financial services.[16]
The implementation of e-money in Japan has been both successful and rapid. Cultural attitudes and dense urban living have played a part in this success: the Japanese were already utilising their mobile devices for more than just telephony, a shift in consumer preferences that is now becoming more widespread in Europe illustrated, for example, by the growing popularity of Apple’s iPhone applications. Cultural differences aside, it is evident that both standardisation and accessibility of technologies have played an integral part in the Japanese success story.
The future of e-money in Europe
Whilst the revised EMD has removed many of the legal barriers to the issue of e-money, based on the Japanese experience, a sufficient level of technology standardisation and accessibility for consumers is vital for the further growth of e-money in Europe.
Near Field Communication (NFC) technology, the standard used by the FeliCa solution in Japan, has already generated interest within the UK.[17] Similar technology is already used by the e-money issuer sQuid, which has launched contactless payment cards for use with a variety of retailers in Bolton and Dundee and has conducted trials of contactless payment cards in selected Dominos, Pizza Hut, Subway and Coffee Republic retail outlets,[18] although it remains to be seen whether such schemes will enjoy sustained customer support.
Although only briefly discussed in the new EMD, perhaps the most important factor for the success of e-money will be trust. Sufficient consumer trust has long been established with cash and, in more recent decades, debit and credit cards. One means of building consumer trust in e-money in the short term is through the use of branding, for instance launching e-money services under brands that consumers already trust. Future e-money schemes could be launched to leverage existing marketing success, in a manner similar to the co-branding of credit cards.[19]
Conclusions
The Commission anticipates that the new EMD will offer a second chance for the e-money market to take off, with volumes expected to reach up to EUR 10 billion by 2012.[20]
The new EMD has removed a number of regulatory barriers, making it more viable for potential issuers to move into the market and for established issuers to expand. That said, there is no clear answer to how MNOs would address redeemability requirements within their existing business models. Consequently, whilst the uptake of e-money services offered by MNOs has the potential to be an area of substantial growth (as seen in Japan), MNOs may continue to be deterred if the payment services that they offer to customers are not made subject to specific exemptions from redeemability requirements.
More generally, whilst removing regulatory barriers to the issue of e-money may act as a catalyst to the growth of e-money, further market growth will require significant investment in technologies and infrastructure, and collaboration between service providers to develop attractive propositions that will prompt consumers to rethink payment methods used on a day-to-day basis. Ultimately, significant commercial commitment and consumer buy-in will be essential for the successful growth of e-money in Europe.
Ruth Wilson (ruth.wilson@herbertsmith.com) is an Associate at Herbert Smith LLP, London. Roksana Moore (roksana.moore@qmul.ac.uk) is a Ph.D. Candidate at the Centre for Commercial Law Studies, Queen Mary College, University of London
[1] http://register.consilium.europa.eu/pdf/en/09/st03/st03666.en09.pdf
[2] http://europa.eu/rapid/pressReleasesAction.do?reference=IP/05/930. The review was mandated under Article 11 of the original EMD (2000/46/EC)
[3] http://europa.eu/rapid/pressReleasesAction.do?reference=IP/05/930.
[4] (2005/60/EC) and (2006/48/EC) respectively.
[5] (2007/64/EC)
[6] Commission Staff working document, SEC(2006)1049, on the Review of the E-Money Directive 2000/46/EC, p. 15
[7] Vouchers or points provided free by an issuer to recognise customer loyalty would not constitute e-money for the purposes of the legislation
[8] A ‘limited network’ would include restricting acceptance of funds to the purchase of goods and services from a specific retailer, a chain of participating retailers or for a limited range of goods and services, regardless of the geographical location of the point of sale (for example, store cards, petrol cards, meal vouchers and public transport smart cards such as Transport for London’s Oyster card)
[9] http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2007:319:0001:0036:EN:PDF
[10] At section 4.3 of the UK Treasury Consultation on the revision of the E-money Directive and implementation of the EU Regulation on cross-border payments in Euro, January 2009, http://www.hm-treasury.gov.uk/d/consult_emd_200109.pdf
[11] An industry body in the UK comprised of the UK’s five MNOs – O2, Orange, T-Mobile, Vodafone and 3, and the largest mobile virtual network operator (MVNO), Virgin Mobile
[12] Consultation on the revision of the E-money Directive: A response from the Mobile Broadband Group, April 2009, http://www.mobilebroadbandgroup.com/documents/mbg_emd_rev_140409_f.pdf
[13] Final report of the study on the Evaluation of the E-Money Directive 2000/46/EC, p. 74
[14] This can be further increased to EUR 500 by competent authorities at a national level
[15] Mobile Contactless Payments In Europe: The Reality Beyond The NFC Hype, Forrester, July 2009
[16] Mobile Contactless Payments In Europe: The Reality Beyond the NFC Hype, Forrester, July 2009
[17] For example, O2 conducted the UK’s first large-scale NFC trial with 500 participants between November 2007 and May 2008 in cooperation with Transport for London, Barclaycard, Visa Europe, TranSys, Nokia and AEG. During the trial, participants were able to use their mobile phones to travel on London’s transport system and to make payments in retail stores by touching their mobile phones against NFC readers
[18] http://www.squidcard.com/squidcommunities.html
[19] Such as the Barclaycard OnePulse credit card co-branded with Oyster, which offers credit card, contactless and Transport for London’s Oyster card functionality
[20] EUROPA Press Release IP/09/637, available at http://europa.eu/rapid/pressReleasesAction.do?reference=IP/09/637&format=HTML&aged=0&language=EN&guiLanguage=en
