Can there be a better future for e-money in the EU?

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This article was first published in e-finance&payments law&policy, February 2010.

Despite EU legislation being in place, e-money services are still slow to develop. Several directives, between 2000 and 2009, have attempted to give a clear framework to these types of services in order to reassure consumers and boost competition. However, Adam Mitton shows that there is still uncertainty regarding the definition and scope of some types of financial services.

E commerce is an increasingly important and accepted means of buying and selling goods and services. According to figures published by the Office for National Statistics in November 2009(1), the total value of internet sales in non financial sectors in the UK in 2008 was £222.9 billion, an increase of 36.6% from 2007. As the volume of e commerce has increased, the use and number of e money and other internet based payment services have also increased. Regular users of e commerce websites will have encountered – and may well have an account with – services such as PayPal, Worldpay, Amazon Payments or Google Checkout. Broadly, internet payment services fall into two categories. First there are services such as Google Checkout, which provide a payment processing solution whereby consumers submit their credit card details to Google who then processes payments for goods and services on participating websites without the need for the consumer to resubmit their details each time. Second, there are services such as PayPal that enable consumers to create an account into which cash can be deposited and used as e money to pay for goods and services bought online from third parties. Both types of services offer clear advantages in terms of efficiency for businesses and convenience and security for consumers. The wonder is not that the number of these e money services is increasing, but rather that there are not more of them.

The late or slow development of these services may simply be due to the fact that e commerce is still a relatively young concept. Even in 2009, 30% of households in the UK still did not have narrowband access to the internet - £222.9 billion figure referred to above accounts for less than 10% of non financial sector sales in the UK. Add these numbers to consumers’ fears in relation to the security of credit card information, for instance, and it may be that it is only now that e money and other internet payment solutions are viable as businesses in their own right.

However, another factor may be that unclear and burdensome regulation has also been a barrier to entry. Regulation of these services is derived from European Directives. The first E Money Directive(2) on taking up, pursuit and prudential supervision of the business of electronic money institutions (the “2000 Directive”) came into force in 2000. The aim of the 2000 Directive was to harmonise the legal, supervisory and regulatory framework for e money in Europe to encourage the development of e money services and the creation of a single market for the issuance of e money and provision of related e money services. However, a report commissioned by the Directorate General for the Internal Market published in 2006(3) (the “Evaluation Report) concluded that e money is still far from achieving its full potential, such that the EU Commission and Parliament noted, in 2008, that e money was “not yet a credible alternative to cash”(4). Against that background, a new Directive(5) in relation to the regulation of e money issuers was passed in late 2009 (the “2009 Directive”).

The problems of the regime created by the 2000 Directive related to a lack of clear definition of what amounted to “e money” for the purposes of the 2000 Directive and for the implementing legislation in each Member State, and to the inadequacies and inconsistencies of the supervisory regime for e money institutions.

E money was defined in the 2000 Directive as “monetary value as represented by a claim on the issuer which is (i) stored on an electronic device (ii) issued on receipt of funds of an amount not less in value than the monetary value issued and (iii) accepted as means of payment by undertakings other than the issuer”. Questions have arisen in relation to the first and third parts of that definition.

In relation to the first part, it was unclear whether the definition would apply to internet account based payment schemes. The uncertainty was created by wording in the 2000 Directive that e money can be considered a surrogate for coins and banknotes and the implication that there should be some physical element to e money (as there would be with a smartcard).

In relation to the third part, questions have arisen as to whether the definition of e money would or should include electronic vouchers, mobile network operators’ (MNOs) prepaid services and smartcards for public transport, such as the Oyster card. To illustrate the degree of uncertainty in relation to MNOs and use of prepaid airtime to pay for third party services, the Evaluation Report noted that, although there was no evidence that the 2000 Directive was being applied to any MNO; Member States’ approaches differed considerably. Some (including the UK) followed European Commission guidance issues in 2005 to the effect that, if a scheme is implemented such that there is no direct debtor creditor relationship between the third party merchant and the consumer, that scheme should not be considered e money. Other Member States decided not to apply the 2000 Directive, pending further clarification from the EU Commission. One Member State, however, reported that there was no issue to consider as all MNOs had a banking licence and were appropriately regulated anyway.

There is such a range of interpretations that Member States must have contributed significantly to the slow development of the e money market, especially the cross border market.

In additional to definitional uncertainties, the Evaluation Report and subsequent EU Commission working documents concluded that high capital requirements and other regulatory restrictions of the 2000 Directive coupled with the requirements of the Payment Services Directive (PSD), have also contributed to barriers to entry fro new e money issuers. They concluded that the prudential requirements and restrictions on activities imposed on an e money issuer, which were closely linked to the regimes applied to credit institutions, were excessive and would eventually lead to the absence of a level playing field between payment institutions and e money issuers.

Under the 2000 Directive, an e money issuer was required to demonstrate that they had available initial capital of €1 million to obtain authorisation to operate. In its Working Document, the EU Commission noted that many stakeholders thought this excessive with regard to the risk of providing the service and an obstacle to smaller companies wishing to enter the market. In addition, the 2000 Directive placed tight controls on the ability of e money issuers to invest the funds received in return for the issuance of e money, which put them at a disadvantage compared to fully licensed credit institutions.

The 2009 Directive, which must be implemented into national legislation by 30 April 2011, seeks to address these issues so as to make it easier for new entrants into the e money market.

To address definitional uncertainties, the 2009 Directive defined e money as “electronically including magnetically, stored monetary value as represented by a claim on the issuer which is issued on receipt of funds for the purpose of making transactions … and which is accepted by a natural or legal person other than the electronic money issuer”. The requirement that claims be stored on an electronic device has been replaced with the requirement that the claims are electronically or magnetically stored. In addition, Recital 8 states that the definition of e money should apply to e money stored on a server managed by the e money holder. In relation to the other areas of uncertainty, the 2009 Directive addresses these not in the substantive definition of e money, but in the Recitals. For example, Recitals 5 and 6 provide that the Directive should not apply to instruments such as store cards, public transport cards, meal vouchers or vouchers for services (unless such a specific purpose instrument develops into a general purpose instrument) or to the situation where a subscriber pays an MNO and there is no direct payment or debtor creditor relationship between the subscriber and the third party provider of digital goods or services.

The 2009 Directive also attempts to reduce the regulatory burdens faced by new entrants. In particular, the initial capital requirement has been reduced to €350,000. In relation to supervisory and regulatory burdens, the regime applicable to e money issuers is now more closely aligned to the less restrictive regime applied to payment institutions under the PSD rather than that applied to credit institutions. The 2009 Directive seems to provide greater regulatory clarity and reduce barriers to entry for new providers. Whether this will result in an increase in the number of online payment services remains to be seen. It may be that consumers prefer to trust a small number of established internet brands such as PayPal and Amazon with their details rather than a new entrant. Even if the number of providers does continue to increase, it may simply be a product of a growing e commerce industry rather than the more relaxed regulatory regime of the 2009 Directive.

Footnotes:

(1) www.statistics.gov.uk/pdfdir/ecom1109.pdf
(2) Directive 2000/46/EC on the taking up, pursuit and prudential supervision of the business of electronic money institutions.
(3) Final Report on the Evaluation of the E money Directive submitted by the Evaluation Partnership, 17 February 2006
(4) Proposal for a Directive of the EU Commission and Parliament on the taking up, pursuit and prudential supervision of the business of electronic money institutions, amending Directives 2005/60/EC and 2006/48/EC and repealing Directive 2000/46/EC.
(5) Directive 2009/110/EC amending Directives 2005/60/EC and 2006/48/EC and repealing Directive 2000/46/EC.