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Saturday, 21 January 2012

Should Central Banks Supervise Facebook Credits?

This is an interesting question that I've been keeping an eye on for sometime now. Forbes is the latest media outlet to wonder whether Facebook Credits are going to be deemed systemic and somehow in need of regulatory supervision. They cite estimates that Facebook Credits total "$470 million of revenue in 2011, or about 11% of Facebook’s total business."

Financial regulators haven't been terribly interested in Facebook Credits because they merely constitute 'closed loop' stored value, rather than 'open-loop' stored value or 'e-money'. The line of demarcation is somewhat open to conjecture, but as explained below it seems likely that the Facebook Credits programme (as currently configured) will remain outside the scope of regulation. However, Facebook could decide to make things really interesting by 'opening the loop'  to become a full-scale e-money issuer...

When you buy Facebook Credits you're really just buying a 'claim code', like you would a music download, and that code is redeemable for purchases of items on the platform. The code is purchased from and redeemed by the same Facebook entity (if you're a resident of or have your principal place of business in the US or Canada, it's Facebook, Inc., otherwise, it's Facebook Ireland Limited). This means the suppliers of items you buy don't actually redeem the Facebook Credits themselves. Instead they rely on Facebook to process that transaction, and the suppliers receive only 70% of the price of the items sold, after Facebook deducts its commission or fees. The terms and conditions also make it clear that the 'credits' aren't able to be re-sold or transferred to anyone outside of Facebook. All of this means Facebook Credits are 'closed loop' stored value.

Typically, the European Commission has been the most aggressive in trying to comprehensively regulate e-money (and everything else!). That's largely arisen from efforts to break open the continental 'banking monopoly', starting with retail payments. As a result, issuing e-money in the European Economic Area (EEA) is a regulated activity under the second 'E-money Directive', and its use in retail payment transactions is covered by the Payment Services Directive. The two directives have been implemented in the UK by The Electronic Money Regulations 2011 and the Payment Services Regulations 2009. Essentially, this creates a framework within non-banks can be authorised to process retail payments.

Key regulatory requirements related directly to E-money include official authorisation/supervision, minimum and ongoing capital requirements and the need to safeguard (insure or segregate) money corresponding to outstanding E-money. “Electronic money” is defined as:
"...electronically (including magnetically) stored monetary value as represented by a claim on the electronic money issuer which—(a) is issued on receipt of funds for the purpose of making payment transactions; (b) is accepted by a person other than the electronic money issuer; and (c) is not excluded by regulation 3;" [my italics].
Parking the various issues with the real meaning and scope of "payment transactions", it's clear from the relevant terms and conditions that Facebook Credits are not accepted by anyone other than the relevant Facebook entity. Technologically speaking, it also seems likely that none of the suppliers of items purchased with Facebook Credits would be able to recognise and redeem the unique claim codes. Furthermore, both of the regulation 3 exemptions are relevant in the context of Facebook Credits:
"3. (a) monetary value stored on instruments that can be used to acquire goods or services only—
(i) in or on the electronic money issuer’s premises; or
(ii) under a commercial agreement with the electronic money issuer, either within a limited network of service providers or for a limited range of goods or services;"
which is generally referred to as the 'limited network' exemption; and a 'digital goods' exemption (which also applies to services) for:
"...(b) monetary value that is used to make payment transactions executed by means of any telecommunication, digital or IT device, where the goods or services purchased are delivered to and are to be used through a telecommunication, digital or IT device, provided that the telecommunication, digital or IT operator does not act only as an intermediary between the payment service user and the supplier of the goods and services."
The digital goods exemption is pretty clear cut, and probably applies to most of what Facebook Credits are used for. But being able to pay for a trip to the movies, as Forbes reports occurred in the US last summer, would likely fall outside the EU digital goods/services exemption if it occurred in the European Economic Area. So that puts pressure on the extent to which Facebook can claim to be a "limited network" of service providers or only providing access to "a limited range of goods or services". And if that exemption fell away, we'd be back to whether a participating merchant could be deemed to be 'accepting' Facebook Credits. 

The meaning of "limited" is left undefined in the legislation, probably to give the authorities a broad enough discretion to act where they think it's necessary or appropriate. However, the ordinary dictionary meaning does not equate to 'small', 'narrow' or 'few', so the size of the programme of itself shouldn't be a problem.

Nevertheless, it seems that the scope, scale and growth of the Facebook Credit programme is continuing to provoke policy discussion about its regulatory status, particularly as to whether there are systemic grounds on which Facebook should be segregating customer funds related to oustanding stored value and whether it has some kind of unfair cost advantage over authorised E-money institutions.

I discussed the policy issues related to operational risk, safeguarding and competition concerns in the context of other limited network offerings during the UK consultation on the introduction of the 2011 regulations. Incredible as it may seem, I think these will recede as the eventual scale of 'proper' E-money issuance will gradually grow to vastly exceed the quantity of Facebook Credits in issue - unless Facebook decides to enter the E-money market itself and go 'open-loop'. Now that would be interesting.