MEPs Agree To Cap Card Fees (#MIFs)

Based on the recent deal amongst MEPs, it looks like the Merchant Interchange Fees (MIF) Regulation will sail through the EU Parliamentary process in early 2015.

#Crowdfunding the EU

Suddenly it's all go on the EU crowdfunding front.

I'm still digesting last week's ESMA opinion on crowd-investing and the advice on how to regulate it, which is to be followed by the European Banking Authority's view on the regulation of P2P lending.

It's too early to expect anything conclusive - both ESMA and the EBA say they are merely supporting the Commission in its broader efforts to embed crowdfunding in a range of policy areas - but it's good to see official recognition of the benefits of crowdfunding, as well as the risks, and some sunlight on the highly technical challenges to accommodating the new business models. Let's hope they consider how any changes will impact customer experience, marketability and the need to scale these platforms quite quickly.

In addition to regulatory reform, it would be great if the EU agenda could evolve to include realigning traditional tax incentives to boost personal investment in new asset classes.

More on the detail soon!

Thoughts On The Growth Of EU #Crowdfunding

I've just spent a fascinating few days at the ECN Crowdfunding convention in Paris this week discussing the development of crowdfunding across the EU. The main focus was on regulation, since that is perceived as being the key difference from country to country. But of course there are other factors involved and these were also covered in the presentations. In particular, crowdfunding is a huge marketing challenge, given the vast advertising budgets of mainstream financial services providers and customer inertia. There are also many perverse incentives and implicit subsidies favouring the traditional financial models. I helped explain such problems in a recent submission The Finance Innovation Lab to the Competition and Markets Authority on retail/SME banking, for example.

A European twist on the scale and nature of the competitive problems was emphasised by an early presentation from our hosts, BpiFrance, a state financial institution targeting traditional funding at SMEs. It has 2000 staff in 37 offices and arranged funding of €10bn for 3500 French SMEs in 2012 alone. So not only do French crowdfunding platforms face a banking monopoly, but they must also compete against direct public programmes. With that kind of competition, it's little wonder the French crowdfunding market is only a twentieth the size of the UK! Thankfully, Bpi appears to have switched to supporting the development of many new private platforms, rather than trying fund plug the French SME funding gap all by itself - rather like the strategy adopted by the British Business Bank.

Of course, the SME funding gap is not exclusive to France. Christian Katz, CEO of SIX, the Swiss stock exchange, explained that the EU's 23 million companies face a funding gap of 2 trillion over the next 5 years. Yet only 11500 have access to the public markets. Currently, SMEs are creating 1 job for every 5 that big companies are eliminating. In other words, the companies that create the jobs are starved of access to working capital.

This kind of problem is not simply financial, and Joachim Schwerin, Policy Officer, DG Industry & Enterprise gave an excellent presentation on Friday explained how Crowdfunding features in five of the EC's key policies for stimulating economic growth:

• Improving access to finance, especially for SMEs;
• Financing projects that have found it hard to obtain traditional finance
• Boosting the digital economy
• Increasing the level of entrepreneurship, which is completely lacking in many EU countries; and
• Enhancing democracy, by enabling people to mobilise their savings to produce financial returns, rather than always having to trust their funds to banks and other traditional intermediaries that may not actually have their interests at heart.

Joachim outlined plans for extensive guidance to SMEs on types of crowdfunding via the EC's "Access to finance for SMEs" portal, highlighting the opportunities for SMEs rather than just focusing on the risks to investors. So watch that space during early 2015.

Many delegates were pressing Joachim to outline an EU regulatory timetable, but he was right to point out that this is premature. He confirmed that the EC is still in listening mode, which is as refreshing to hear now as it was in October. Regulation does not create markets, as the EC has discovered in its regulation of consumer credit and contract law. Indeed, it is plain from the recent French law and German proposals that regulating without an understanding of the market could kill them altogether.

For instance, the French authorities have limited participation in P2P lending to individuals who may only lend up to €1,000 per project/borrower. The authorities say this is necessary to ensure that lenders diversify the total amount they lend. This seems harmless enough until you realise the marketing challenge faced by someone starting a brand new P2P platform who cannot rely on a few large lenders to fund the bulk of early loans, or to step in where liquidity is scarce from time to time. Yet in more developed markets there is no evidence that lenders fail to diversify. In the latest UK market study Nesta has found that 88% of lenders say they engage in P2P business lending because they think diversification is important, which is supported by the figures:

"The average P2P business lending loan size is £73,222 and it takes approximately 796 transactions from individual lenders to the business borrower to fund a listed loan, with the average loan being just £91.95. P2P business lenders have, on average, a sizeable lending portfolio of £8,137 spread over a median of 52 business loans."

As a result, project-by-project caps are not a feature of the regulation of P2P lending in the UK, nor the rules allowing wider retail participation in crowd-investment. These regulations only took effect in April 2014, well after these markets were firmly established, well understood, and were able to benefit from the credibility that proportionate regulation can bring without being strangled by red tape.

Finally, it was interesting to hear Christian Katz's recommendations to help ensure the success of crowdfunding in the EU, based on how stock exchanges have developed:

• Clear, common terminology;
• Code of conduct - especially promoting transparency - e.g. disclose the details underpinning credit ratings;
• Platform stability/availability;
• Fund recovery - safeguarding customer funds and how to get money out;
• Cross-border - don't ignore potential that the Internet brings;
• Positioning crowdfunding - e.g. as a source of pre-IPO funding (under €5m).

Each of these points merits a post in its own right, but an EU code of conduct would seem to be a good way to focus market participants on achieving them. The team at ECN presented some early thoughts. Clearly the code will need to be consistent with applicable national laws and accommodate all the different types of crowdfunding. It should also be negotiated by the CEOs of platforms, as they understand the development plans for their own businesses better than the lawyers and the policy staff. Such codes have already been agreed by the leading participants in more developed markets. For example, the Peer-2-Peer Finance Association (P2PFA) has developed Operating Principles specific to P2P lending, and the UK CrowdFunding Association (UKCFA) has produced its own code of practice to accommodate donation-based and investment-based crowdfunding.

While it is possible that specific enabling regulation may be necessary in some countries to initiate the ability to establish dedicated crowdfunding platforms (e.g. allowing normal loans to be concluded on such platforms, rather than only participation loans, or lifting the €100,000 limit on equity crowd-investment in Germany, for example), the EC's approach of allowing platforms to develop in line with self-regulation seems the wiser than rushing to regulate in detail.

Lack of Transparency In Negotiation Of #PSD2

I don't think the Beurocrats are terribly concerned by rampant Euroscepticism pervading national electorates. The byzantine EU legislative process trundles on as secretively as ever. All the nonsense about immigration is a nice distraction from lack of transparency on more fundamental issues.

The latest attempt at a fait accompli is the revised proposal for a new Payment Services Directive (PSD2), which is designed to shape the EU's payment systems for the decade to come. Having published several drafts previously with some attempt to mark-up the changes from previous meetings of member state representatives, a rapid-fire draft (dated 21 November) was suddenly published on 24 November, the same day it was due to be debated.

Today, as a result of the 24 November negotiations, a further draft (dated 1 December) was published without any changes marked, along with a recommendation that it be used as the basis for negotiations with the EU Parliament. Never mind that alternative service providers and other stakeholders with minimal lobbying power are attempting to understand and warn of the impact of seismic changes to the payments regulatory framework.

This is no way to approach the regulation of the EU financial system - if you have any interest at all in bringing the market along with you. But it's a perfect way to leave control of the market to the major banks and card schemes who have lobbyists plugged into the process.

Rant ends. I'll be trying to update my article on the changes to the proposals in the coming week.

Though it's hard to see the point.

Card Scheme MIF Regulation [Updated 20 Jan 2015]

In addition to a new Payment Services Directive (PSD2), the Beurocrats have been busy on a Regulation aimed at payment card transactions - mainly to cap merchant interchange fees, but also to introduce some 'business rules' (MIF Regulation). Unlike PSD2, the MIF regulation will take effect directly in each member state, rather than having to be implemented into national law first. The caps on fees described below apply from 6 months after the regulation enters into force, while the grace period for the business rules is 12 months after the regulation enters into force. The MIF regulation must be reviewed by the Commission four years after entering into force, with any recommendation to amend the fee cap. Underlining and strike-through reflects changes made to the MIF Regulation since October 2014.

Capping fees:

The January 2015 version of the MIF Regulation (updating the October 2014 version) caps the hidden interchange fees that card issuers receive from merchant acquirers for cross-border all debit card transactions at 0.2%. However, for domestic debit card transactions, Member States may apply either a lower cap per transaction and a fixed maximum fee amount, or allow payment service providers (PSPs) to apply a per transaction fee of up to €0.05 in combination with a maximum percentage rate of no more than 0.2%, provided that the interchange fees of the payment card scheme does not exceed the fee is capped at a weighted average of 0.2% of the annual transaction value of the domestic debit card for all transactions within each payment card a scheme, or 0.2% per transaction. But for 5 years, Member States may allow PSPs to apply to domestic debit card transactions a weighted average interchange fee of up to 0.2% of the annual average transaction value of all domestic debit card transactions within each payment card scheme, or a lower weighted average if they wish.

The interchange fee for each credit card transaction is to be capped at 0.3%, although member states can reduce this for domestic transactions.

If domestic payment transactions are not distinguishable as debit or credit card transactions by the payment card scheme, the provisions on debit cards or debit card transactions apply. However, for 1 year after the fee caps apply, Member States may rule that up to 30% of the indistinguishable transactions are considered to be credit card transactions to which the credit card cap shall apply.

At these levels, the authorities believe that retailers should not be allowed to impose additional charges for use of cards that are subject to the caps (such 'surcharging' is controlled by PSD2). However, cards issued to businesses ('commercial cards') and those issued by 'three party payment schemes' (like Amex) are exempt from the caps. That's because businesses are thought to be able to fend for themselves (unlike consumers); and in a three party scheme all fees are charged by the scheme operator, so both the consumer and the merchant know who's paying what to whom. In those cases, then, the merchants can charge for the pain of accepting such cards and it's up to the scheme operators whether to lower their fees. But there are certain limits to the exemption for three party schemes.

In addition, the caps will not apply to 'limited network' payment instruments (like gift cards) which:

• allow the holder to acquire goods or services only within a limited network of service providers under direct commercial agreement with a professional issuer; or
• can only be used to acquire a very limited range of goods or services; or
• instruments valid only in a single Member State provided at the request of an undertaking or public sector entity and regulated by a national or regional public authority for specific social or tax purposes to acquire specific goods or services from suppliers having a commercial agreement with the issuer.

Confusingly, however, there's a similar exemption under PSD2 which carries an additional limitation that “The same instrument cannot be used to make payment transactions to acquire goods and services within more than one limited network or to acquire an unlimited range of goods and services”. So it's conceivable that a scheme may be exempt from the need to be authorised under PSD2, yet have its interchange fees regulated under the MIF Regulation.

Business Rules:

The MIF Regulation has some additional 'business rules':

1. there can't be any territorial licensing restrictions on scheme membership within the EU;
2. card schemes (other than three party schemes) must: ensure their system is technically interoperable with other systems of processing entities within the EU; must separateensure the rule-making entity is independent from entities providing payment processing and other services; eliminate cross-subsidies among scheme services; and not make any one service conditional on taking or providing another;
3. all card schemes must:

• allow 'co-badging', so that a single card can be accepted under multiple schemes;
• enable co-branded instruments on the same card, if possible, but give clear and objective information on the different instruments and their characteristics;
• not discriminate between issuers or acquirers concerning co-badging of payment brands or applications or in terms of reporting, fees or other obligations, routing of transactions or by using mechanisms that limit the choice of application by payer and payee when using a co-badged instrument (though prioritising is okay);
• not charge fees on a blended basis for different card types, unless requested;
• not insist that all their types of cards are honoured if a merchant only wants to accept some of them (and so must enable customers to readily distinguish between the different types of cards offered by the scheme);
• not prevent retailers ‘steering’ customers toward using a preferred payment method, without prejudice to rules under the PSD or the consumer rights directive.

While the MIF Regulation is reasonable advanced, the UK Payment Systems Regulator (PSR) recently warned that if the adoption of the MIF Regulation is delayed, or the implementation of its domestic fee caps is deferred from the caps on cross-border interchange fees, it will consider taking action in advance of the Regulation; and that it may still consider whether it is appropriate to take any further action even if the MIF Regulation is adopted.

In other words, official trust in card schemes is low.

Payment Systems Regulator Publishes Regulatory Proposals

It's all go in the payments world at the moment. The EU is trying to hammer out a new payment services directive (PSD2), while the UK's new Payment Systems Regulator (PSR) is setting up shop ahead of its official launch in April 2015.

The PSR has just announced the results of a joint market study with Ofcom on the level of innovation in the payments sector, which casts doubt on certain aspects of PSD2.

In addition, the PSR has published its response to an earlier consultation on its proposed rules for regulating payment systems. The term "payment system" is defined very broadly as:

“a system which is operated by one or more persons in the course of business for the purpose of enabling persons to make transfers of funds, and includes a system which is designed to facilitate the transfer of funds using another payment system.”

The intention behind the rules are to:

• set a new approach to industry strategy development - a new 'Payments Strategy Forum';
• change the governance and control of payment systems to ensure greater transparency and representation of users in decision making, avoidance of conflicts of interest, publication of board minutes and compliance reports to the PSR;
• make it easier for participants of all sizes to access payment systems – directly or indirectly;
• action on interchange if EC regulation is delayed; and
• require system operators to discuss significant developments with the PSR in advance and on an on-going basis.

If the rules still aren't to your liking, you have until 12 January to kick up a fuss.

The Updated Updated Review Of #PSD2

The European Council produced a further update of the proposed new Payment Services Directive (PSD2) in late October, and I have now updated my review article for the SCL, as well as the posts assessing the impact on:

• loyalty schemes, including store card and gift card programmes;


• third party gateways and other technical service providers;


• the providers of the newly regulated payment initiation and account information services; and


• security, innovation and competition.

Adding Peer-to-Peer Loans To #ISAs

The Treasury is consulting on how to implement the government's decision to allow us all to hold peer-to-peer loans within our Individual Savings Accounts (ISAs). This is revolutionary because it increases the range of assets that can be held in ISAs - increasing diversification and therefore the value of the ISA portfolio - and significantly improves the visibility of where your investment money ends up (as I've argued for some time). Adding P2P loans will also change the way ISAs and ISA managers operate, which raises the various questions that the Treasury is consulting on (set out below). This post explains the difference between P2P lending and investing in funds typically held in stocks and shares ISAs, and addresses the main issues outlined by the Treasury.

What are peer-to-peer loans?

Peer-to-peer (or 'P2P') loans are just simple loans agreed directly between lender and borrower. There is no bank or fund manager in the middle, and the operator of the platform on which the loans are agreed is not a party to the loans.

How is P2P lending different to investing in funds?

Perhaps the best way to understand the difference is by starting with the role of the fund manager as opposed to the P2P platform operator. In simple terms, a fund manager collects money paid by investors in return for 'units' in the fund, and then controls the investment of that money in its own name (or that of the fund entity) - so the manager controls the management of the money or other assets in the fund, not the investors,.

However, the operator of a P2P lending platform enables many lenders to lend small amounts of money directly to many different borrowers, and then simply administers the individual loan contracts in accordance with their terms.  So the lenders on a P2P platform, rather than the platform operator, keep control over the management of their money and loan contracts. This is a key reason why P2P loans are a fundamentally different asset class to units in investment funds.

What does this mean for ISA managers?

These differences present a challenge for today's ISA managers - whose job it is to enable you to invest using your annual ISA limits, and keep track of those for HMRC.

Currently, when you buy units in an investment fund through an ISA manager, the manager adds your order to many other orders that it receives and then buys the total number of units in the investment fund in its own name. Each unit is standardised with the same price/value and issued by the same entity. The manager then records how many units it bought on your behalf in its own systems. You have no direct contract or any other link with the investment fund at all.

But on a P2P platform, you agree many small loans directly with lots of other people for the purposes specified, and different platforms tend to specialise in different types of loans (personal loans, working capital for small businesses, commercial property etc). Everyone's holding is different, even though some lenders end up lending to the same borrower. You also directly agree the platform's fee, if any, which may be waived in some cases (sometimes the borrower pays the fees, for tax reasons, leaving the lender with just the net income).

So existing ISA managers will probably need to make systems changes to enable it to track your own unique holdings of P2P loans in your ISA, and it seems likely they'll want to see a lot of demand before they do so. Accordingly, to meet demand for P2P loans in ISAs it's likely that the operators of P2P lending platforms will become ISA managers in their own right.

What does this mean for ISA rules?

You will probably be able to withdraw P2P loans from ISAs without having to sell them and take the cash.

ISA assets can typically be transferred between ISA managers, but that isn't practicable between different P2P platforms, so it's likely that any transfer would only work by selling the loans and transferring the cash directly to the other ISA manager. However, the Treasury is not sure whether to require this, as it could discriminate against platforms that do not have ready secondary markets for the loans agreed on their platforms. Another reason not to insist on transferability is that even if there were a secondary market, there could be a delay in finding a buyer for the loans, as opposed to just waiting for them to be repaid; and a 'forced' sale could mean a low market price, even from a market-maker or underwriter.

The Treasury is also interested in arrangements for continuing to manage P2P loans in ISAs in the event that the P2P platform operator ceases to qualify as an ISA manager, similar to the FCA requirements for administration of loans in the event that the operator ceases to trade.

The Treasury is still not sure whether to allow P2P loans to be kept in their own ISA or in a stocks and shares ISA. However, assuming P2P platforms are likely to need to become ISA managers in their own right, it would seem unduly onerous to make them apply for the extra FCA permissions required to offer other investments available through stocks/shares ISAs. So I'd suggest that there will need to be a third 'P2P loans ISA', or at least the ability for platform operators to offer a stocks/shares ISA that is limited only to holding P2P loans.

The Treasury expresses some concern that P2P lending on behalf of children through Child Trusts Funds (CTFs) or Junior ISAs could mean that the parent or guardian and not the child will be the one who understands the business activity or loan purpose of the business/personal borrower. But this is no worse than investing in a managed fund where you don't know the precise mix of the constituent stocks/shares or even the actual issuers and therefore their businesses or use of proceeds.

Finally, the Treasury believes that title to P2P loans made via CTFs and Junior ISAs would need to be held by the ISA manager or some third party, as loans made by minors are not enforceable (as a matter of contract law).

Those Treasury questions in full:

1. In relation to the proposals generally, what necessary set-up costs (one-off costs) would be necessary for your business to arrange peer-to-peer loans meeting the proposed eligibility requirements for ISAs? What would be the estimated ongoing annual costs of doing so?
2. Do respondents agree that the government’s proposed approach provides sufficient clarity as to which peer-to-peer loans will be eligible for ISA inclusion?
3. Do respondents agree that the proposed regulatory requirements strike the correct balance between investor protection and a proportionate regulatory regime?
4. Are existing ISA managers considering offering peer-to-peer loans alongside other ISA eligible investments? What factors may affect this decision?
5. Are firms operating peer-to-peer platforms considering seeking authorisation to act as ISA managers if the government permits this? What factors may affect this decision?
6. Do respondents have any concerns regarding FCA-authorised firms operating peer-to-peer platforms being allowed to act as ISA managers? If so, what are they?
7. Do respondents see any risks arising from firms operating peer-to-peer platforms approved as ISA managers not being required to have legal ownership of peer-to-peer loans held within ISAs?
8. Are there any drawbacks to the proposed withdrawal procedure for peer-to-peer loans? If so, what are they?
9. If the transfer requirement is applied to peer-to-peer loans – do respondents foresee any risks or detriment for consumers resulting from the proposed modification of the current ISA requirements? If so, what are these?
10. Following the sale of the peer-to-peer loan and transfer instructions from the investor, what would be the most appropriate time period within which the cash realised should be transferred?
11. Is the proposed modification to transfer requirements t likely to present any difficulties or administrative obstacles for ISA managers (including those receiving transfers)? If so, what are these?
12. What are respondents’ views on requiring the existence of a secondary market in order for a peer-to-peer loan to qualify for ISA eligibility? Would such a requirement provide a useful degree of reassurance to investors?
13. Would a requirement to offer a secondary market pose any problems or difficulties for peer-to-peer platforms and if so, what are these? Could secondary market arrangements of this type be easily defined?
14. Do respondents think that a guarantee of a sale at market value within a given period would be desirable in addition to the proposed requirement of a secondary market?
15. Is there merit for investors in requiring that there must be a mechanism by which loans can be sold at market value within a given period? What period should this be, taking account of the times taken at present to achieve sales on existing secondary markets?
16. Are there other ways in which to facilitate transferability, besides those described above? If so, how might these work?
17. Overall, do respondents feel that the benefits to investors from applying transfer requirements to peer-to-peer loans held in ISAs outweigh the possible risks of doing so?
18. Do respondents have suggestions as to how loans held within ISAs could continue to be managed by an ISA manager in cases where either a firm operating a peer-to-peer platform collapses and they were acting as ISA manager, or where such a firm becomes ineligible to act as an ISA manager following removal of its FCA permissions?
19. How important is it that investors should be able to mix peer-to-peer loans with other eligible investments within their ISA in a single tax year? Do respondents believe most investors wishing to place peer-to-peer loans into an ISA account will additionally want to invest in other types of non-cash ISA investments within the same tax year?
20. Would a third ISA type be helpful in alerting investors to the different rules which will apply to peer-to-peer loans within ISAs? Overall, would a third ISA type aimed specifically at alternative finance products such as peer-to-peer loans be a good thing – and if so, why?
21. What potential difficulties or challenges might the creation of a third ISA type present for savers, investors, ISA managers or others?
22. If the government decides not to introduce a third ISA type, how can we best ensure that customers are clear about the special characteristics associated with peer-to-peer loans, for example that they are not covered by the FSCS, and that they may be difficult to liquidate?
23. Do respondents have any concerns about offering a tax advantage where loans made by or on behalf of children might be made without knowledge of the intended recipient(s) or usage of the loaned funds? If so, what are they?
24. Do respondents agree that if peer-to-peer loans are made eligible for CTFs and Junior ISAs, these loans should be in the legal ownership of the ISA manager? If not – what alternative approach might be considered?

Regulatory Creep Hits Big Loyalty Schemes - Updated

Store cards, gift cards and loyalty rewards are currently exempt from payments regulation where they are only accepted within the issuer’s premises or certain ‘limited networks’. The new European Payment Services Directive (PSD2) extends the scope of this exemption - which is helpful to some extent - but also introduces a notification requirement that will bring big schemes within the regulatory sphere from 13 January 2018, and oblige the authorities to decide whether the exemption is available. This post explains the changes, and the options open to the operators of such schemes. For other significant changes proposed under PSD2, see my longer SCL article). The Treasury's consultation on introducing PSD2 in the UK has just been published.

The limited network exemption under PSD1 applies to services based on instruments that can be used to acquire goods or services only: (a) in the premises used by the issuer; or (b) under a commercial agreement with the issuer either (i) within a limited network of service providers or (ii) for a limited range of goods or services (my numbering/emphasis).

The exemption under PSD2 is for:

"services based on specific payment instruments that can be used only in a limited way, that meet one of the following conditions:

(i) instruments allowing the holder to acquire goods or services only in the premises of the issuer or within a limited network of service providers under direct commercial agreement with a 'professional issuer' [not defined];

(ii) instruments which can be used only to acquire a very limited range of goods or services;

(iii) instruments valid only in a single Member State provided at the request of an undertaking or a public sector entity and regulated by a national or regional public authority for specific social or tax purposes to acquire specific goods or services from suppliers having a commercial agreement with the issuer." (my emphasis)

Some guidance as to what is meant by 'limited' or 'very limited' is to be found in the relevant recital to PSD2, which states:

"Instruments which can be used for purchases in stores of listed merchants should not be excluded from the scope of this Directive as such instruments are typically designed for a network of service providers which is continuously growing."

In addition, operators of large limited network schemes will be obliged to notify the regulator “if the the total value of payment transactions executed over the preceding 12 months exceeds the amount of EUR 1 million”. The regulator must then decide whether the exemption criteria actually apply, and notify the service provider if the regulator concludes that it does not. There is no provision for a transition period to explore alternative methods of supporting the scheme.

This means that loyalty scheme operators need to consider now whether their scheme will be covered by the revised limited network exemption in January 2018 and, if not, whether they should outsource the operation of the programme to an authorised firm (or the agent of one); or seek their own authorisation (or agency registration). Ultimately, they might restructure the scheme to fit the exemption, or shut it down.

The UK Treasury was due to issue its consultation paper in August 2016 on how it plans to implement PSD2, but has not done so yet. Hopefully, either the Treasury and the FCA will clarify further how they plan to handle the notification process, including whether pre-clearances will be possible during 2017, for example, given the lack of any transition period should the FCA conclude that the exemption does not apply.  Otherwise, queries arising out of any uncertainty in the application of the exemption might be directed to the FCA's Innovation Hub. 

This kind of regulatory 'scope creep' is not at all healthy, however. PSD2 should be clearer on what activities are in or out of scope. Instead, we have activities that are out of scope altogether; in scope but exempt; in scope with authorisation required; in scope with registration required; or in scope with only notification required (as here).

The question also remains why loyalty schemes are being targeted in this way. There is no evidence of any harm to consumers in such scenarios, as discussed in the context of earlier plans by the UK Treasury to propose self-regulation to ring-fence retail loyalty scheme funds (here and here).  It seems a case of mistaken identity with retail pre-payment schemes such as operated by Farepak and certain tour companies which don't appear to be caught anyway.  Similarly, there is no distinction made for 'limited network' schemes whose rules do not allow cash to be obtained by either redeeming the limited network value or seeking a refund for a purchase made using that value.

[First published 23.10.14, and since updated to reflect the change to the notification threshold; again to reflect the removal of 'unlimited' in a late draft of PSD2; and again to include the date when PSD2 takes effect in national law]

Developing EU Policy On #Crowdfunding

I've finally had a chance to catch up with the minutes of the initial meeting of the EC's "European Crowdfunding Stakeholders Forum" (ECSF) in late September. Clearly these are still early days and the Commission is rightly (and rather atypically!) waiting to see how the various types of crowdfunding develop at national level, rather than rushing to regulate.

Unfortunately, it seems there was no time to take account of the UK regulations on P2P lending and crowd-investment, which took effect on 1 April 2014. These are cited in either the European Banking Authority's submission to last December's EU crowdfunding consultation, or the AK Wien high level review of various platforms.

That's a pity, since the UK regulation addresses all the various issues raised in those reports relation to peer-to-peer lending and crowd-investment.

It's interesting that the AK Wien report calls for rewards/donation-based crowdfunding to be regulated like in similar fashion, the UK declined to include that activity - and even the US has excluded donation-based funding from the otherwise all-embracing US securities framework. Perhaps AK's concern is that Europeans won't even start rewards/donation platforms without explicit permission to do so. That would be consistent with the civil law expectation that governments should specify which activities are lawful, rather than the common law view that the law should follow commerce where necessary to resolve issues that arise. But, unfortunately, that's no way to foster the growth of a nascent industry, as the Commission has recognised in its subtle approach to this area so far.

It's encouraging, however, that both the Commission and the ECSF seem to be taking a holistic approach to crowdfunding generally. That also reflects the Commission's approach to regulating payment services, on which the UK industries' self regulatory approach to crowdfunding has been based. At least that may produce a more unified set of rules, rather than the FCA's multiple rule books governing the same operational risks at the platform level. Perhaps a more unified approach will emerge from the FCA's review of the effectiveness of its rules in 2016.

In the meantime, the ECSF should also consider whether there are any tax incentives for personal investors that may be impacting the growth of alternative financial services. Again, the UK policy work in this area should be instructive, as discussed in the Treasury's consultation on proposals for including P2P loans in Individual Savings Account 'wrappers'.

Now Damages for Searches Revealing Good Memories About Bad Memories

A hat-tip to Miquel Peguera of Stanford for his analysis of a recent Spanish case in which Google Spain SL was ordered to pay compensation to one Sr Domingo for the 10 months it took to prevent access to certain information about him as ordered by the Spanish Data Protection Authority. The case arose from a claim for damages by Sr Domingo under the Spanish equivalent of section 13 of the UK's Data Protection Act 1998.

 

As in the recent González case in the European Court, the 'bad' information being linked to had been published by law. In fact, in this case the material was a Royal Decree granting a pardon for a previous criminal conviction for violating health regulations. The problem appears to be that the pardon (naturally) referred to the conviction for which the pardon was granted.

 

I'm really struggling here, I must say. 

 

Is there no public interest in being able to locate Royal Decrees generally through search engines?

 

If it is somehow wrong to reveal the details of a pardon, why doesn't the State remove the details of both the previous criminal proceedings and the pardon, so that none of the details are available for search engines - or anyone else - to find?

 

If the pardon and previous conviction must remain a matter of public record, isn't the pardon actually good news?

Maybe the appeals court will make sense of all this. But I'm not holding my breath.

A Short History Of The P2P Marketplace Model in UK Finance

During a recent panel discussion at the annual conference of the Society for Computers and Law, I explained briefly how the online peer-to-peer marketplace, pioneered by eBay in the US, came to be applied in financial services in the UK. The slides are here, and below is a slightly longer written explanation. Note that the focus is on the history, rather than explaining the differences between various types of 'crowdfunding'.

eBay pioneered person-to-person sales of second-hand items in the US from 1995, proving the concept to be hugely attractive. The particular "'Aha!' moment" came when people actually paid for the item they'd agreed to buy, not to mention the delivery of the item.

In 1999, the team at X.com (later PayPal) expanded the eBay model into payments by enabling consumers to pay each other using a credit card. This was rapidly adopted by eBay users (to the point where eBay eventually had to buy PayPal as a defensive measure). Coincidentally, in the same year it became clear to the entrepreneurs who had created PlusLotto, an online lottery in aid of the Red Cross, that the payment part of their system, which enabled people to prepay funds in many different currencies to centralised bank accounts then log-in to their data accounts or 'wallets' to purchase lottery tickets with the balance, should be made available to other merchants. They started Earthport as a separate payments provider the same year, and I was among those asked to join the board of the new entity. The initial strategy was to roll-out the wallet offering directly to consumers and merchants. But in 2000 we raised £25m through a private placement - literally weeks before the DotCom bubble burst - to fund a switch in strategy. The plan was to leverage the marketing budgets of banks, telcos and major Internet portals to offer own-branded wallets to their customers. Of course, those plans ran into the headwind created by the tech slump. But I'm happy to report that Earthport remains alive and well.

Meanwhile, in 2003, a team at artistShare in the US adapted the P2P payments model to enable music fans to donate money to fund musicians and music projects. The reason for this donation-based model of 'crowdfunding' was the need to avoid US securities regulation, which is notoriously rigid and complex, and applies expensive registration requirements even to very simple loans. The battle to liberate that regime continues to this day (see below).

At any rate, late in 2003, a small group of executives left Egg, the internet bank (which also happened to be one of Earthport's early customers), to try to reinvent financial services. During their brainstorming process, Dave Nicholson, suggested 'eBay for money' and the idea took hold. Coincidentally, they approached me in the summer of 2004 to see if I could help avoid any US-style regulatory problems. By the time we launched Zopa, the P2P lending platform, in March 2005 we had moved away from the idea of eBay-style 'auctions' to a more automated marketplace for personal loans. Borrowers and lenders had told us they did not want to reveal too much about themselves to each other, but were happy to give Zopa enough information to guard against fraud, assess creditworthiness and match their bids and offers to produce loan contracts directly between them.

 

In 2010, the team at FundingCircle applied the P2P lending model to the small business lending market. They also enabled direct loans between each lender and business entity. But to provide security for the additional risk of lending larger amounts to businesses, they introduced a separate entity that would hold security over the assets of the borrower in trust for the lenders. That trustee entity could then enforce the security on the lenders' behalf if the borrower defaulted under the P2P loans. Since then, this model has also been introduced to the commercial property sector.

It was only a matter of  time before the P2P marketplace model penetrated the investment world. In 2011, Crowdcube launched the concept of enabling many individual investors to finance unlisted start-up companies in return for shares. And a team that included Bruce Davis, an ethnographer who had helped develop both Egg's and Zopa's marketing propositions, launched Abundance Generation to fund alternative energy projects by selling long term debentures to retail investors who could use the returns to pay their own energy bills.

 

The same year, the Peer-to-Peer Finance Association was launched to call for proportionate regulation of the peer-to-peer lending sector.

 

Since 2011 many different types of P2P lending, crowdfunding and crowd-investment platforms have launched. Approximately 30 platforms signed a letter to EU and UK policy makers at a P2P finance policy summit held in London in December 2012, and many others have launched since.

 

In March 2014, the first FCA rules took effect which specifically regulate both peer-to-peer lending and crowd-investment. The EU has since convened a "European Crowdfunding Stakeholders Forum" to help determine whether there is scope for EU regulation to help develop the sector.

 

Clearly we are still witnessing the dawn of this trend. 

 

PS on the US:

 

While this post has focused on the UK, it is worth mentioning that we attempted to launch Zopa's P2P model in the US during 2006-07. However, it was clear from our own regulatory discussions, and the subsequent experience of Prosper.com, that the Securities Exchange Commission was determined to view simple loans as securities that require registration and intermediation using the same model that applies to more complex instruments. Zopa declined to launch that type of model, but it had to be deployed subsequently by Lending Club and Prosper (a similar version was also deployed by Prodigy Finance in the UK, due to the need to support international cross-border lending activity). Essentially, rather than agreeing loans directly with individual borrowers, investors buy bonds that are backed by loans made to those borrowers by a licensed lending entity. The lending entity sells the loans to the bond issuer, which distributes the loan repayments to the bondholders. While the JOBS Act was supposed to liberate crowdfunding in the US, the SEC has been less than enthusiastic in implementing it. Fortunately, UK regulators have been positively supportive and it's important to note that the SEC does not have any responsibility to promote innovation and competition, while the FCA clearly does. 

Feedback on FCA Project Innovate Workshops

The Financial Conduct Authority has published its summary of the feedback it received in relation to its proposals to support innovation in financial services ("Project Innovate").

A striking aspect is the negative, limited view of innovation from established, regulated firms, compared to small innovators and non-regulated firms. This seems to underscore how protected the existing providers have been from external competition to date.

Worth providing feedback on the summary, and any solutions to problems identified.

Following the Financial Innovation Lab session in May and the Project Innovate session I attended in August, I still recommend a short 'small firms registration process' that would allow all new firms to enter the market more quickly and operate under certain thresholds before going through the lengthy full authorisation process if they can succeed in growing (as for small payment/e-money institutions).

PSD2, The Saga Continues - Updated

The European Council issued its revised proposal for PSD2in September 2014.

The Society for Computers and Law has kindly published an update to my earlier article on PSD2 to reflect the revised proposal.

Possibly the key issues relate to:

• limiting the technology service providers exemption to those who supply their services to payment service providers, rather than users - for example, this would no longer seem to apply to 'gateway' data services supplied to merchants/retailers, as opposed to acquirers;
• the distinctions between technology services, on the one hand, and services involving payment initiation, account access, bill payment and acquiring;
• the inconsistent treatment of bill payment services, e-commerce marketplaces and the suppliers of public communications networks (telcos);
• the notification requirements for large store card, gift card and loyalty programmes and other 'limited network' payment schemes;
• the requirement for payment service providers to release to payers the names of payees who refuse to surrender funds that have been paid to them by mistake;
• host state reporting for cross-border service providers, in addition to home state reporting;
• prescriptive security provisions affecting different types of payment service provider, which must meet (as yet unpublished) standards issued by the European Banking Authority;
• e-money institutions having to provide fresh evidence that they meet the threshold conditions for authorisation.

Interested in hearing your thoughts, either here or via the SCL site.

 

The Role of Consumer Contracts, Advice and Disclosure

Great discussion at a CSFI event this morning, focusing on the difference between financial advice and guidance, and touching on the FCA's very encouraging plans to support a far better consumer experience and more innovation generally. A key theme in the discussion centred on the role of consumer contracts in the supply of financial services, and it was clear there needs to be more discussion on the tension between regulation, contracts and product information. 

Of course, the starting point was that lengthy consumer contracts are 'silly' - a point made by John Kay last year and discussed on the SCL blog. But it's important to recognise that contracts act as a layer between law and regulation and the information a consumer sees when buying and using a financial service. They represent a service provider's public statement of how it interprets the law and regulation to apply to its service. That statement is critical not only for consumers themselves, but also for the courts and many stakeholders on whom consumers rely to protect them (indeed governments have even deputised global service providers as private sheriffs, relying on violations of their terms of service to 'shut down' Wikileaks, for example). In addition, financial instruments - loans, bonds, shares - that are agreed or traded in the course of using most financial services are themselves simply sets of terms and conditions.

The reason consumers are confronted by such terms and conditions is that the courts have insisted that consumers must be given an opportunity to read and agree them if they are to govern the customer relationship. It is this interactive process of offer and acceptance that produces an enforceable "contract" (along with some form of 'consideration'). Unless and until Parliament changes the basis for establishing contract law in the UK, we're stuck with that approach. 

Yet this morning it was suggested that a consumer should not even need to the opportunity to read and agree terms and conditions in order to benefit from them. Revolutionary stuff, unless you live on the continent, where a lot more of what we see as contractual terms are embedded in civil codes. This of course removes a lot of commercial flexibility, and means the market moves at the speed of law and regulation... which would undermine the FCA's object of promoting innovation.

Of course, the financial services sector is arriving late to the debate about how to enable consumers to properly agree and understand the substance of a contract without necessarily drilling into the fine print unless they so wish. The intellectual property community came up with the Creative Commons licensing model in 2001 and, more recently, the World Economic Forum has been trying to foster a similar approach to the use of personal data.

But the critical issue in every case is whether the simplified summaries that consumers see and agree actually reflect the terms and conditions on which a firm says it is doing business; whether those terms and conditions are consistent with applicable law and regulation; and, finally, whether the firm's business processes and computers actually operate on the same basis. Here we run into the tension between Big Data and the growing array of technology that puts you in control of Your Data - data about you, or which you generate in the course of your activities.

This is certainly not an area where the FCA can go it alone, and it's great to see their representatives (not to mention someone from the Treasury) participating in open debates such as the one this morning. 

Consultation On New Mortgage Rules

The UK Treasury is now consulting over the rules required to implement the European Mortgage Credit Directive by March 2016.

Importantly, the proposed rules will regulate second charge mortgages (also known as second charge loans, secured loans or secured personal loans) into line with first charge mortgage lending; and introduce a new set of regulations for buy-to-let lending, where the lending is to consumers rather than for business purposes. This is not expected to affect the vast majority of buy-to-let lending which is done for business purposes and therefore not subject to the European directive.

The consultation is open until early November 2014.

UK Remains Calm Over Virtual Currencies

Despite the ECB's recent attempt to "discourage" EU financial institutions from trading or holding virtual currencies, the UK Chancellor has explained that the UK will conduct its own investigation into the potential for virtual currencies, like Bitcoin, to encourage innovation in the financial sector, while also considering the risks and how best to mitigate them. 

This perfectly illustrates the common law adage that 'the law must follow commerce', as opposed to the civil law view that the State should first prescribe whether and how business should be done - a distinction that Eurocrats really need to understand. As George Osborne noted: 

"it is only by harnessing innovations in finance, alongside our existing world class knowledge and skills in financial services, that we'll ensure Britain's financial sector continues to meet the diverse needs of businesses and consumers here and around the globe".

 

Entrepreneurs: Help The FCA Help You!

Great news: the Financial Conduct Authority is continuing its efforts to support innovation in financial services, and is offering both entrepreneurs and innovative firms the chance to sense-check its approach.

Following the session with the Finance Innovation Lab in May and its June announcement of Project Innovate, the FCA has just issued a mercifully short consultation paper on its plans and arranged a series of summer workshops on:

• how entrepreneurs can get authorised more efficiently; 
• figuring out how non-regulated businesses can engage with the FCA in an Innovation Hub to help them collaborate with regulated businesses while avoiding the need for regulation; and 
• how regulated firms could engage with innovative firms and the FCA via the Innovation Hub.

Specific questions on which the FCA also welcomes your answers before 5 September are:

1. Is there anything about the regulatory system that poses particular difficulties for innovator businesses?
2. What practical assistance do you think the Incubator could usefully provide to small innovator firms?
3. Do you think it would be useful to establish an Innovation Hub function?
4. What criteria should we use in order to focus our resources on ‘genuine, ground-breaking’ innovation?
5. Do you have any other feedback or suggestions about Project Innovate?

This is a fabulous opportunity for everyone in the UK's FinTech sector to help the FCA improve its authorisation and guidance processes to support new businesses, so please get involved.

EBA Seeks To Freeze Link Between Actual And Virtual Currencies

On Friday, the European Banking Authority advised EU national financial regulators to "discourage" credit institutions (banks), payment institutions and e-money institutions from buying, holding or selling virtual currencies, based on over 70 risks that it says will require substantial regulation. The EBA says that should include bringing virtual currency exchanges which deal between virtual and actual currencies within the anti-money laundering regime.

Somewhat cryptically, the EBA concludes:

"Other things being equal, this immediate response will allow VC schemes to innovate and develop outside of the financial services sector, including the development of solutions that would satisfy regulatory demands of the kind specified above. The immediate response would also still allow financial institutions to maintain, for example, a current account relationship with businesses active in the field of VCs."

But there are many flaws in the EBA’s approach, and it undermines the EU’s potential as a home for financial services innovation. A lot more work should have been done - and the EBA should have engaged with the market participants publicly and constructively - before taking such disruptive action. Especially given that those participants (including venture capitalists and possibly financial institutions) should have a legitimate expectation to be able to continue their lawful involvement, unless the law is changed by the usual process. 

The EBA concedes as much by saying that it is too early to collect enough data to understand exactly what they are "shielding" financial institutions from: 

"...the phenomenon of [virtual currencies] being assessed has not existed for a sufficient amount of time for there to be quantitative evidence available of the existing risks, nor is this of the quality required for a robust ranking."

So what is the basis for intervening in this way now? Gut instinct?

There is obvious duplication and overlap amongst the risks identified and many “are similar, if not identical, to risks arising from conventional financial services or products, such as payment services or investment products”, as are the regulatory controls that are suggested for the longer term. Key benefits of virtual currencies are also dismissed in the context of the EU and Eurozone on the basis of regulations that are yet to take effect. 

Oddly, the EBA points to a risk that regulating virtual currencies more leniently will create an unequal playing field that could result in service providers leaving fiat currency markets in favour of their virtual cousins. Surely that risk is heightened by denying financial institutions early access to virtual markets altogether. Has the EBA learned nothing from the rise of shadow banking? Won't this breed weak regulated institutions? Won't entrepreneurs simply operate outside the EU, leaving its institutions unable to capitalise on opportunities that virtual currencies might have brought? 

And why would the EU want to discourage borderless financial services while it's trying so hard to kickstart cross-border commerce?

A requirement for fully comprehensive regulation cannot be the price of institutional participation in virtual currency markets. There is a flawed belief amongst Eurocrats that ‘vigorous regulation’ is a pre-condition for consumer trust, as Paul Nemitz recently asserted. But that is not supported by the way in which the digital economy has evolved. Regulation can help build on existing trust, but cannot create trust where none existed before. This difference between the civil law and common law view of the role of regulation needs to be resolved in favour of a more acommodating EU approach to innovation and competition if the EU member states are to compete globally. For instance, the UK Cabinet Office convened a workshop on financial innovation in October 2013, which featured a session on virtual currencies; and UK revenue officials were helpful in merely clarifying their tax treatment of virtual currencies earlier this year. More recently, the Financial Action Taskforce (FATF) was also much more circumspect in a report that was intended to “stimulate a discussion” on how to introduce risk-based anti-money laundering controls in the context of virtual currencies. 

The EBA's intervention is further evidence that the EU financial regulatory regime needs to be much more open to innovation and competition if we are to avoid the pitfalls discussed in the Parliamentary Commission on Banking Standards.

A more detailed review of the EBA opinion has since been published at the Society for Computers and Law.

FCA Announces #ProjectInnovate

Hard on the heels of the Transforming Finance workshop, the FCA announced in a speech by CEO Martin Wheatley last week that it will support innovators by: 

• providing 'advice on compliance' to firms who are developing new models or products advice so they can navigate the regulatory system;

• looking for areas where the system itself needs to adapt to new technology or broader change – rather than the other way round; and

• launching an incubator to help innovative, small financial businesses ready themselves for regulatory authorisation.

The umbrella term for these initiatives is "Project Innovate". I look forward to hearing more about it, including contact details etc.

How The FCA Could Support Innovation And Diversity In Financial Services

Hats off to the Financial Conduct Authority for hosting and participating in The Finance Innovation Lab's recent workshop on Transforming Finance. It was an excellent, productive discussion and seems likely to help drive helpful change. For the sake of transparency, here are my notes/thoughts (unattributed, on the basis of Chatham House Rules).

The FCA board is interested in how the financial services market can be 'disrupted' in ways that are positive for consumers and small businesses. There is a new awareness of how regulatory uncertainty can be a barrier to entry/growth; and the need to get better at recognising the harm that comes from stifling good initiatives.

Key aspects of beneficial disruption include, innovation, diversity, and competition. There is evidence that competition within markets alone is insufficient, and can actually drive mis-selling (e.g. banks competed to sell PPI). Increasing diversity is also necessary, to enable competition amongst different business models and services in the same market. This requires the FCA to consider how firms outside the regulated markets are delivering better consumer outcomes, as well as firms within the regulated markets.

Greater transparency around fees, incentives and conflicts of interest allows excessive fees to attract competition and/or disintermediation; and the removal/re-alignment of perverse incentives and conflicts of interest.  

FCA could foster innovation with: 

• a 'sandbox' for entrepreneurs/innovators to consider how new models might be impacted by rules - this could include an online method for extracting all the rules in the Handbook that relate to a certain product or activity; 
• pre-authorisation workshops to coach firms through the evolution to authorsiation and obtain feedback on problems and potential improvements; 
• a shortened, small firms registration process that would allow new entrants to operate under certain thresholds before going through the lengthy full authorisation process (as for small payment/e-money institutions);
• a small firms unit made up of staff from each of the FCA's main 'silos' to ensure joined-up focus on innovation and diversity, consistency, fairness and positive discrimination in favour of sensible initiatives.

The regulatory/policy environment needs to be more open and accessible. We need to know which staff are responsible for what. The FCA tends to draft its rules and communicate in its own unique language, rather than in the language of the markets it regulates or even the same terms used in directives/regulations it is supposed to implement. It also needs to 'get out more', and participate in more forums involving firms, trade bodies, policy officials from relevant departments (e.g. Treasury and BIS) and the European Commission. There should be more public roadshows, roundtables etc - perhaps the FCA could host an annual, wider version of the P2P Finance Policy Summit that was run in December 2012? The consultation process should more positively discriminate in favour of those outside the incumbent firms, it should be more socially networked with a more widely telegraphed timetable. In this context it would also be helpful for the FCA to keep a register of who is lobbying it (e.g. as Ministers must disclose). There should be a body to scrutinise what the FCA (and HMT) is consulting on and how the consultation process operates.

The FCA views the market through the lens of products, and types of firms and their activities, rather than from the standpoint of the customer and how the customer can be empowered to achieve their own financial outcome. The customer is seen as victim, whereas the tide of technology and innovation is delivering greater control to the customer (e.g. over personal data - and financial transactions are just another type of data).

The FCA needs to participate in the debate over the best means of credit creation - should we separate banks' role in money creation from their role in actually allocating credit? Should we strip banks of their role in creating money altogether, as covered by Martin Wolf recently. 

How do we distinguish genuine innovation or invention from merely incremental changes to existing models/products? New rules should be tested for their potential impact on diversity, innovation and competition.

The Financial Services Consumer Panel and Smaller Business Practitioner Panel should have specific obligations to consider the above issues, as well as the interests of alternative finance providers and civil society more generally.

Interested in your thoughts!