Shifting Sands: The FCA Considers Gift Cards Outside The Scope Of PSD2

The sands are shifting under the legal status of gift cards, as the UK's Financial Conduct Authority consults on guidance that removes them from the scope of e-money and payments regulation altogether, rather than deeming them to be excluded as "limited networks". This interpretation would at least remove the need for large gift card programmes to be registered with the FCA, but also suggests a divergence from EU payments law in the Brexit context, to the extent that other EEA regulators may well decline to adopt the FCA's interpretation. Ultimately, it is unclear whether a gift card programme might yet somehow fall within the regulated scope but still benefit from an exclusion.

What's a "gift card"?

Gift cards have always represented the advance purchase of goods or services from the retailer who issued the card. Sometimes the value is recorded on the card (or voucher) itself, sometimes it is represented by a credit to a specific account for the card or named customer in the retailer's IT system. In either case, such value is considered 'closed loop'. There is a subtle difference between this and paying for a specific item in advance. But in both cases, the retailer has been able to treat the funds paid by the purchaser as its own funds, so that the customer has always taken on the risk of the retailer going bust before the value could be redeemed or the specific item was delivered (think Farepak and Wrapit).

Gift cards vs "E-money"

Electronic money, on the other hand, requires you to first 'load' value to a device or account (or 'e-wallet') which the "issuer" then enables you to use to pay for purchases at a range of retailers who either participate on the issuer's proprietary platform, or who accept the issuer's 'prepaid debit cards' via the major card schemes. In this sense, e-money is 'open loop'. Here, the customer is taking the risk that the e-money issuer might go broke before the customer can spend the e-money with the retailers. The risk of this has always been considered much greater than the risk of an individual retailer's insolvency, so financial regulators were given powers to control e-money issuance to try to eliminate that risk. The first electronic money directive in 2000 ("EMD") therefore obliged e-money issuers to hold sufficient capital to avoid insolvency and to keep the cash corresponding to their customers' e-money balances separate from the issuer's own cash. They defined "electronic money" as being stored value that is accepted as a means of payment by an entity other than the issuer, thereby excluding 'closed loop' stored value that is issued and spent or redeemed with the the same entity. 

Exemptions for "limited networks"

The closed/open loop distinction was carried through into the first payment services directive in 2007 ("PSD") by explicitly excluding from the definition of "payment services" any "services based on instruments that can be used to acquire goods or services only in the premises used by the issuer or under a commercial agreement with the issuer either within a limited network of service providers or for a limited range of goods or services". This provision became known as the "limited network exemption".  

That exemption was effectively endorsed in 2009, when the second e-money directive ("EMD2") defined "electronic money" by reference to the value being used for the purpose of making payment transactions under the PSD, rather than accepted by an entity other than the issuer.  The reference to the PSD thus automatically picked up and relied on the limited network exemption. 

In 2010, the Treasury proposed an obligation for retailers to segregate their gift card funds, but failed to attract any support. The limited network exemption then evolved into a narrower "limited network exclusion" by 2015 under the second payment services directive ("PSD2"), yet Question 40 of the FCA's Perimeter Guidance still cites "a closed loop gift card" as benefiting from that exclusion.  

In addition, PSD2 requires limited networks which transact more than €1m in any 12 month period to be registered with the local financial regulator, which then has a duty to determine whether the limited network exclusion actually applies to it. The first 12 month period expires on 13 January 2019, with registration due on 10 February. This has obliged retailers to begin tracking the size of their loyalty programmes to determine if and when they need to register, and the consequences of a finding that the programme is not excluded. In essence, the retailer could find itself prosecuted for having operated an e-money and/or payment service without either being authorised or registered as an agent an authorised firm (subject to any 'due diligence defence').

Gift cards now out of scope altogether?

In its latest consultation, however, the FCA proposes to change its stated view by removing the gift card example from Q40 and instead stating:

"... in our view, ‘gift cards’ where the issuer is a retailer and the gift card can only be used to obtain goods or services from that retailer are not payment instruments within the meaning of the PSRs 2017. This is because these basic gift cards do not initiate payment orders; payment for the goods or services is made by the customer to the retailer of the goods in advance, when the card is purchased from the retailer. Accordingly, this exclusion is not relevant to them."

But does that analysis extend to server-side stored value that can only be spent with the issuer? It is also at odds with the fact that VAT is not assessed on gift card purchases to avoid duplication, since VAT will in any case be levied on the actual purchase of items from the retailer in due course (let's ignore 'breakage', where the consumer leaves a balance that the retailer eventually takes to revenue). 

Wider consequences?

While this may be factually and logically correct, and might come as a relief to some large retailers, it otherwise creates confusion and "regulatory creep" as firms take action beyond what is required in order to avoid uncertainty - such as shutting programmes, outsourcing or applying to register unnecessarily. It involves an apparent re-interpretation of the relevant definitions to overlook what may be regarded as certain 'legal fictions' in the PSD and PSD2 that operate particularly in relation to card payments, for example. It also represent a key area of potential divergence from EU payments law in the Brexit context, to the extent that other EEA regulators may well decline to adopt the FCA's interpretation - the Central Bank of Ireland, for example, includes gift cards in the list of programmes that fall within the limited network exclusion. 

At the same time, however, the FCA's view does not alter the need for retailers to be careful about the implications of any changes made to their programme, in case they find that the limited network exclusion does then apply and needs to be registered.