Do Payment Account Balances Held By A Payment Institution Without A Payment Order Constitute E-money?

Interesting opinion in ABC Projektai UAB v Bank of Lithuania, where the regulator had said that a payment institution had engaged in e-money issuance merely by holding funds for which it had received no payment orders. I've advised on this issue before, but this post is not legal advice, so let me know if you need it.  

The Advocate General's view is that a payment institution which holds funds without executing a payment order will infringe Articles 78 and 83 of PSD2 (as locally implemented) which govern the timing of receipt and execution of payment orders; potentially breach the service contractual for the operation of the payment account; and may trigger liability for non-/late execution under Article 89. 

But the funds would not be somehow converted into e-money "merely because funds have been transferred to a payment account and are kept in that account for the execution of future payment orders." 

There was also no e-money involved because the steps required for issuance of e-money under the E-money Directive (as implemented locally) were neither contemplated by the parties nor actually followed. 

It's worrying that there were in fact no payment orders (rather than, for example, existing payment orders that were not yet deemed to have been received by virtue of article 78(2) PSD2). The PSP had said that it had warned customers to provide payment orders or their funds would be returned (though the firm had not actually returned them...😬). Consistent with the AG's overall reasoning, however, the view must be that this will only amount to a breach of PSD2, rather than somehow convert the payment account balances into e-money. 

E-commerce Marketplaces, Commercial Agents and PSD2

E-commerce marketplaces are now common in most sectors, enabling suppliers and consumers of all types of goods and services to find each other, contract directly, pay or be paid, arrange delivery and download their transaction data. But action being taken by some payment service providers (PSPs) suggests that many marketplace operators who offer this service in the European Economic Area may not have realised that the payment step needs to be structured in a way that avoids the need for the operator to be authorised by an EEA financial regulator as a payment institution or e-money institution under the Payment Services Directive or E-money Directive (depending on whether the supplier or customer is able to hold a balance in their 'account').

Some financial regulators, like the UK's Financial Conduct Authority, take the view that offering a payment service or e-money service has to be the operator's regular occupation or business in itself to fall within the scope of the PSD or EMD in the first place (the "business test"), although the payment step would need to be a small, ancillary part of the service offered and this is open to interpretation. But less pragmatic or experienced regulators around the EEA might apply the Directives simply because the operator is running a business of any kind. 

This means operators should err on the side of structuring their activities to avoid holding balances and to take advantage of an exclusion under the Payment Services Directive (e.g. for commercial agents authorised to negotiate or conclude contracts on behalf of either the payer or payee); or involve a PSP to handle the receipt and distribution of funds (or become the registered agent of a PSP). 

Other exclusions under the PSD or EMD may also be helpful. But even relying on an exclusion can be somewhat tricky because the interpretation of exclusions can vary from regulator to regulator across the EEA; and there is no 'passport' for one regulator's interpretation as there is for regulated PSPs who can offer their service across the EEA from under authorisation in their home member state. 

That means an operator should seek legal advice on how to structure its activities appropriately under the law of its home EEA member state; and if that involves relying on the local regulator's interpretation of the business test or an exclusion, the operator should check that analysis works under the law of each member state where the operator has a presence or significant numbers of participants (whether suppliers or their customers).  Acting on formal legal advice should also make it less likely that a regulator will take action for acts or omissions consistent with that advice, although it will not necessarily stop a regulator requiring a different structure going forward.

Review of E-money Regulation: More Regulation For Retailers?

The European Commission has just reported on the status of EU e-money regulation, raising the prospect of more regulation for retailers who offer 'gift cards' and other loyalty schemes.

Electronic money, or "e-money" is basically electronically stored value that can be used to make payments to people other than the issuer, while "limited network" or 'closed-loop' stored value can only be used to pay the issuer (as with a loyalty points scheme, fuel card or gift card, for example).

E-money is not to be confused with "crypto-currencies" like Bitcoin, Ether etc. which are not considered "funds" for regulatory purposes because they are not 'fiat' currencies that are backed by governments as a matter of law ('legal tender').

The issuance of e-money was first regulated distinctly from banking by the EU in 2000, under the E-money Directive (EMD) which was replaced by a new directive (EMD2) from 2011. By then the activities of electronic money issuers/institutions (EMIs) had also become regulated under the Payment Services Directive (PSD) from 2009, which was replaced in mid-January 2018 by regulations implementing PSD2.

Inconsistencies

These directives are supposed to be applied the same way by all member states in the European Economic Area (28 EU member states plus Iceland, Liechtenstein and Norway). But the Commission has found that EMIs "engage in "forum shopping", choosing to register in the Member States that provide the most beneficial legal frameworks from their viewpoint." EMIs can then use a "passport" process to offer their services in the remaining EEA member states.

For example, the Annex to the report shows that the UK is home to 87 of the EU's 172 E-money institutions (EMIs), with Malta being the next most popular base (13) then Cyprus (10). This also means that the 87 EMIs based in the UK will need a new base in one of the remaining EEA member states from which to passport their EEA-facing services after Brexit.

The UK is also home to 19 of the EU's 74 small EMIs (who transact less than €3 million a month over a 12 month period), with the Netherlands home to 23 and Latvia 12. But small EMIs have no passport rights, anyway, so do not raise the same concerns.

Benefits of EMD2

The benefits of EMD2 were cited as more clarity and lower capital requirements than EMD1; on top of the fact that payment services regulated under PSD2 and e-money services can be provided under the EMD2 authorisation.

The Commission did not find any consumer harm associated with using e-money or redeeming it for cash (withdrawing the funds equivalent to their e-money balance to another payment account or via an ATM).

Compliance costs are said to range from 1% to 5% of overall costs (€25,000 to €500,000) offset to some degree by the reduction in capital requirements from €1 million under EMD1 to €350,000 for full EMIs under EMD2 (compared to €125,000 for full payment institutions under PSD2).

Issues

Negative factors associated with EMD2 were found to be mainly the inconsistencies in how each EEA member state views the role of an EMI's "agent" (which the EMI has to register) and "distributor" (of which an EMI just has to notify its regulator); and "limited network" or 'closed-loop' stored value, which is unregulated. The inconsistencies make it more difficult to predict the regulatory status and related requirements from case to case and state to state.

EMIs also complain that banks won't allow them to open bank accounts as easily as other types of firms, although the Commission hopes this will be improved by various access provisions in PSD2, and moves by central banks to allow EMIs (and PIs) access central bank accounts and settlement systems.

Next steps

The Commission will explore ways to improve consistency in interpreting the role of agents, distributors and "limited networks". In addition, it will consider making large 'limited network'  providers subject to some (unspecified) aspects of EMD2, even though they must already register with the local regulator when their network transaction volume exceeds €1 million over a 12 month period).