This episode on the Payments Podcast explores what steps banks and payment service providers should take in order to respond to the opportunities and threats presented by PSD2 in this increasingly competitive payment landscape.

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Podcast Transcript

Rich Williams: Hello, welcome back to the Payments Podcast. This is part two of our series on how banks need to prepare for PSD2 and we re-join speaking with Marcus Hughes at Bottomline Technologies.

There's clearly a lot of planning and testing going on across Europe for this. So, what's the current level of preparedness of the market for PSD2?

Marcus Hughes: Well, there's definitely a lot going on, I agree, but I am sorry to say that it's probably not going fast enough at this quite late stage. Like open banking in the UK, PSD2 was introduced in January 2018 across the European Union but the European Commission has allowed a transition period until 14th September, at which time the regulatory technical standards will become into force.

In advance of that September 2019 deadline, European Union based banks are required to be ready to test their APIs by 14th March 2019. This deadline was a really important indication of banks' readiness for PSD2. Independent research indicated that 41% of banks and payment service providers were unable to meet the requirement to be ready to test their APIs.

So, 1,000s of banks and third party providers across the European Union are still preparing and testing APIs in advance of that September deadline. I think part of the problem here is that the European Commission felt that imposing a single API standard would be anti-competitive. So, the European Commission left the technical details of PSD2's APIs completely open, encouraging market forces to define these new rules.

Now, unfortunately, this position risks creating fragmentation and a number of different consortia have been formed to develop their own APIs at a national or regional level. So, we've had the Berlin Group, which consists of 40 banks and payment associations. They've been defining a common API standard called NextGenPSD2, but this is only one of several initiatives across the European Union, such as STET, which has developed their own standard set of APIs just for French banks.

Ironically, the European Union's decision not to impose a common API standard does risk creating unnecessary complexity to opening up bank data because different banks and countries across the European Union may adopt different API standards. This in turn puts at risk the PSD2's timeline and could ultimately impact the success or failure of this very ambitious undertaking.

The fragmentation of API standards across the European Union is at least a great opportunity for API aggregators, but it does make connectivity and set up much harder. Another major challenge to the adoption of PSD2 is that unfortunately, payment services users, both consumers and businesses, still know very little about PSD2. So, the reality is, they will not necessarily be very interested unless banks and third-party providers are able to educate them on the value of PSD2.

Customer inertia could therefore prove a major barrier to adoption of PSD2 services, unless the customer value propositions are very compelling. In other words, what are the tangible benefits for various market segments of consumers or businesses. In this task I can't really emphasise enough how important it is for banks and third-party providers to talk the same language as their customers.

Consumers and businesses don't want to hear about four letter acronyms like PISP and AISP. They want to hear about how the new services deliver value to them and solve customer pain points. Like improved cash flow, lower fees or easier access to credit. A worrying example of the low education levels regarding PSD2 is that banks and third-party providers need to do much more to educate merchants about those requirements for strong customer authentication.

Some more recent research suggests that only 25% of merchants across the European Union are aware of these requirements, which will be in force from 14th September this year. In addition, only 14% of European Union online merchants actually support strong customer authentication today. So, there's a lot of work to be done.

Another challenge faced across Europe is that a number of countries are only just beginning to introduce real-time payments. In order to get the full benefit of PSD2, the market really needs to drive real-time payments to scale. Without real-time payments, those payment initiation services lose a good part of their attraction for being instant, which is considerably faster and lower cost than card payments.

At present, there are only about 1,000 banks adhering to the [SEPA Inst 0:05:28] rulebook and that's only a quarter of European Union banks. So, there's a lot of work to go. For all these reasons, a great deal remains to be done. On the upside, I'd emphasise that the exciting part of PSD2 still lies ahead of us.

Banks and third-party providers need to deliver on the massive potential of PSD2. They've really got to, therefore, develop innovative propositions, launch these new products and drive them to scale. Only this way are they going to start to deliver value to their customers and generate new revenue streams.

Rich Williams: Talking of delivering value, I've heard that PSD2 will allow online merchants to actually reduce their card fees. Could you explain to us how that can be done?

Marcus Hughes: You're quite right. That really is an important opportunity for the online merchants and it's one of the first big business use cases to really take shape, because of the cost-cutting opportunity, I guess. So, an interesting consequence of the introduction of payment initiation services is that it's enabling large online merchants to reduce the high fees they currently pay for receiving payment online by credit or debit card.

So, in view of their ubiquity and their convenience and ease of use, payment cards are the main way in which online merchants are paid for goods and services, but the fees which merchants pay to acquirers and processors and card networks are very high compared to other payment types, often amounting to 2% or more of the value of those goods or services that are being purchased.

These so-called ad valorem pricing models mean that many millions of pounds or euros of card fees are being paid by online giants, which rely on cards, as an easy way to get paid. So, in order to reduce these high card fees, it's expected that the large online merchants will either become payment initiation service providers or partner with a payment initiation service provider.

This will enable this online merchant to obtain payment direct from the customer's bank account and this real-time settlement process will be quicker and less expensive than card payments, thanks to instant SEPA payments across Europe and faster payments here in the UK. There are even predictions that card businesses will see a drop in revenues from online payments, even if other areas like contactless payments are set to continue growing rapidly.

Rich Williams: It sounds like a big win for online merchants, Marcus, but are there any catches we should be aware of?

Marcus Hughes: That's a good point to raise actually. On the one hand, by becoming a payment initiation service provider themselves or using the white-labeled payment initiation services of a regulated fintech partner, the online merchant will be able to make its customer's paying activity a more seamless part of the buying experience. But on the other hand, one of the challenges which merchants might face is that payments made in this way do not currently benefit from chargebacks. 

This chargeback mechanism provides some protection to credit or debit card users in the event that there's a problem with the goods or services they're purchasing. Chargeback isn't actually a legal right, but card companies generally offer this at their discretion. Essentially, the chargeback enables a card issuer to reclaim money from the retailer's bank.

So, whilst many consumers are not aware of this advantage, other more discerning consumers may be reluctant to give up this benefit, making it harder to persuade them to switch payment instruments unless a strong incentive is offered. It's being suggested that online merchants will need to use loyalty schemes, like double air miles to incentivise their customers to give them authorisation to take payment in this manner.

Otherwise, customers may choose not to change. After all, what's in it for them? Cards are very convenient today and they don't cost the consumer anything. So, in fact, the consumer gets free credit if he or she pays off that card at the end of the month. So, why would they change from card payments?

This new trend to replace online card payments to account payments is actually already impacting card networks, which have recently become very interested in non-card payment types. So, for example, back in 2017, when we saw Mastercard acquire Vocalink, the central infrastructure payment provider for BACS and faster payments, and then more recently Visa acquired the payment institution Earthport, while Mastercard acquired Transfast.

Rich Williams: So, talking about these big card networks or card giants, if you like, what about other large tech firms in general? Do you think there's an increased threat of tech giants, as it were, entering the payments market?

Marcus Hughes: Definitely. You're quite right. It's clear that the tech giants, so Google, Amazon, Facebook, Apple, they're all positioning themselves and have started making a decisive shift into payments. There are a number of compelling reasons for this. Payments are fast-growing and a profitable industry. Each tech giant has a very large customer base, mainly consumers, but in some cases, businesses.

As PSD2 gains traction, consumers are going to be the first customer segment to benefit from many of the changes occurring in the payments market. Businesses will also benefit from these innovations, but that'll probably be later. On the whole, the customers of these tech giants trust them, even though there have been one or two isolated concerns about data breaches and how data is actually being managed.

So, the tech giants have huge amounts of data on their customers. They know where they live, they know what they like and dislike, what they do and where they go and even where they want to go. But probably the greatest advantage which these giants have over banks and other current payment service providers is that they use data in a more productive way. Banks don't yet have these skills, which places them at a disadvantage. This is a big area where the banks need to up their game.

So, changing payment services or moving into payment services is a really logical extension of the services and products which tech giants already deliver to their customers. They're well placed to make payments an easy but secure experience and are seen as part of the pleasurable activity of browsing and selecting goods and services.

In this way, payment services provided by tech giants will become more deeply integrated with other activities which consumers already enjoy doing with these tech giants, such as sharing on Facebook, browsing on Google or using their Apple iPhone.

PSD2 certainly encourages competition and is making it easier than ever for tech giants to become accredited to offer payment services. So, as we've seen, thanks to PSD2, these tech giants and other online retailers are going to be able to switch to bank transfer payments and cut out high credit card fees. This is likely to result in lower card volumes being accepted by the large online merchants and the tech giants.

The fact that online merchants will be able to switch to push payments and reduce the volume of card payments being accepted online will ironically help the likes of Amazon and Apple to reduce their card fees. This does look like an unintended consequence of PSD2, since this positive result for these tech giants was probably the last thing on the European Commission's agenda when they were encouraging competition and innovation.

But in launching new payment services, the tech giants will be able to ensure their solutions are highly secure and avoid any data breaches and payment frauds. The tech giants are also making significant moves to position themselves to launch services in payments. For example, Facebook obtained an e-money license in Ireland in 2016. Amazon has a license in Luxembourg and more recently, in December 2018, Google obtained an e-money license from Lithuania Central Bank.

All of these licenses are passportable throughout the whole of the European Union and even after Brexit, it's expected they will continue to be respected here in the UK. It's likely that tech giants will expand, not only into payments but also financing solutions. For example, in order to make it easier for finance purchases at point of sale. A number of recent surveys suggest that tech giants will be offering retail banking services within a few years.

Likewise, we're seeing the major accounting software providers also becoming third party providers. So, Sage, Xero and QuickBooks are also taking up these status as regulated entities and therefore it's clear that there are a large number of new entrants who are coming into the market and this making it increasingly many choices being available to payment service users. I probably ought to read that again.

It's therefore clear that there are a large number of new entrants to the payments market, which is greatly increasing the many choices available to payment service users.

Rich Williams: So, Marcus, hearing about PSD2 today, it's mostly been with reference to European Countries. Is this big change in the way that we pay and get paid just about the UK and Europe, or are there any wider implications?

Marcus Hughes: So, other parts of the world are showing great interest in how the UK and the European Union are implementing PSD2. So, many countries are drawing on our early experiences and are already designing their own versions of this new approach to managing data and payments. For me, the countries adopting open banking and PSD2 can be divided into three categories.

At one extreme, we have places like the UK, Australia, Hong Kong, and the European Union, where the use of APIs is becoming mandatory and a specific timetable is being laid down by the regulators. At the other end of the spectrum, we've got countries like the US, where adoption is market-driven and banks and payment service providers are using APIs to differentiate their product offerings.

And then in between these two categories, we've got countries like Singapore, which is encouraging the adoption of APIs by organic transition, as the Monetary Authority of Singapore likes to call it. So, they're providing encouragement, but without actually imposing new regulations.

Rich Williams: Great, and as we bring this session to a close, do you have any concluding comments for any of the audience listening, Marcus?

Marcus Hughes: Yes, sure. The UK is pioneering experience in real-time payments and open banking and PSD2. It's having a major impact in other countries, as this new approach to data sharing and managing payments gains traction. PSD2 is set to create exciting new services and business models in the coming year and this can only be good news for bank customers and payment service users, whether they're consumers or businesses of all sizes.

And at Bottomline, we're really fully committed to continuing to deliver value and innovation to our customers as this exciting new opportunity evolves, but adoption does take time and there's no big bang here, I'm afraid. So, I'd really caution against people thinking that the whole world will have open banking and PSD2 in the very near term.

For me, adoption's going to be softly, softly over a number of years and when we look back, it's likely to have been a big success, but not immediately. We're going to need to be patient and realistic in our expectations.

Rich Williams: Thank you so much for joining us today, Marcus, and to everyone else for listening in. It's goodbye for now, until our next episode of the Payments Podcast.

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