On July 7, 2017, Canada’s Department of Finance released a long-awaited consultation paper on the proposed regulation of retail payments in Canada. The consultation paper, titled: “A New Retail Payments Oversight Framework” (Consultation Paper) articulates the main components of a proposed federal oversight framework for retail payments (Proposed Framework).
This is a significant development in the Canadian payments landscape as service providers in the retail payments space are generally not regulated except in limited circumstances and in any event, not from a safety and soundness perspective. This is because under the current regulatory framework, focus is placed on the type of entity performing the payment activity and provided that the entity is not taking deposits, not on the actual activity being performed; in other words “who you are, and not what you do”. As such, non-traditional payment service providers, including fintechs (collectively, PSPs), have not previously been subject to regulatory oversight.
The proposals set out in the Consultation Paper break new ground in respect of the regulation of retail payments in Canada and propose a complete regulatory regime for PSPs. Because a PSP is broadly defined in the Consultation Paper, service providers interacting with persons in Canada (including mobile wallet providers and money services businesses) should review the proposals carefully and consider making submissions so that the resulting framework is one that is both workable and efficient for PSPs. The comment period is open until October 6, 2017.
The Consultation Paper recognizes that one size does not fit all in respect of the imposition of regulatory requirements.
In that regard, the Proposed Framework states that the overarching regulatory objective is to approach the regulation of PSPs “using measures commensurate to the level of risk posed by each PSP” through the following three mechanisms:
- Principles-based Requirements: Rather than adopting a “one size fits all” approach, the Proposed Framework indicates that PSPs would be required to implement the regulatory measures described below in a manner that is commensurate with their size, business model and the level of risk associated with their activities.
- Tiered Measures: For lower risk PSPs, there is the contemplation that the regulatory requirements will apply on a tiered basis. For example, PSPs could be tiered on the basis the payment functions they offer (i.e., holding funds), payments values or volumes, market significance (i.e., number of end-users) and the degree of interconnectedness with other retail payment systems or service providers. PSPs representing a lower level of risk could be subject to less stringent requirements.
- Recognition of Other Oversight Frameworks: The Consultation Paper recognizes that for PSPs that are already subject to substantially similar requirements under other federal or provincial statutes, the Proposed Framework would include an exemption process whereby the regulator would be responsible for determining the circumstances in which an exemption should apply. It remains to be seen what in fact the regulator would view as “similar requirements” so as to provide exemptive relief.
SCOPE OF PROPOSED FRAMEWORK
The Consultation Paper provides for the proposed regulation of PSPs performing any one of five core functions in respect of electronic funds transfers that are ordered by an end-user (i.e., a person or entity that is not a PSP or a financial intermediary). It is unclear from the Consultation Paper if the proposed regulations are meant to be limited to the consumer context or whether they will apply in the business context as well.
The five core functions that will trigger regulatory oversight under the proposed regime are:
- Providing and maintaining an account held in the name of an end-user for the purpose of making electronic fund transfers
- Enabling the initiation of a payment at the request of an end-user
- Providing services to approve a transaction and/or enable the transmission of payment messages
- Enabling end-users to hold funds in an account held with a PSP until they are withdrawn by the end-user or transferred to a third party through an electronic fund transfer
- Enabling the process of exchanging and reconciling the payment items (clearing) that result in the transfer of funds and/or adjustment of financial positions (settlement).
The Consultation Paper provides that credit card transactions, online payments, pay deposits, debit transactions, pre-authorized payments and peer-to-peer money transfers are intended to be encompassed by the regulatory regime. From the above core functions, it would appear that both mobile wallet providers and merchant acquirers would fall within the regime.
Certain transactions are proposed to be excluded from the regulatory regime (on the basis that they only pose limited risk to end-users). These exclusions include the following:
- Transactions entirely made in cash
- Transactions conducted via an agent authorized to negotiate or conclude the sale or purchase of goods or services on behalf of the payer or the payee, if the funds held by the agent on behalf of the payer or payee is kept in a trust (e.g., real estate agent or lawyer)
- Transactions made with instruments that allow the holder to acquire goods or services only in the premises of the issuing merchant (e.g., store cards) or within a limited network of merchants that have a commercial agreement with an issuer (e.g., shopping mall cards)
- Transactions related to securities asset servicing (e.g., dividends distribution, redemption or sale) and derivatives
- Transactions at ATMs for the purpose of cash withdrawals and cash deposits
- Transactions between entities of a same corporate group, if no intermediary outside of the corporate group is involved in the transaction
- The clearing and settlement of transactions made through systems designated under the Payment Clearing and Settlement Act.
The Consultation Paper limits the application of the regulatory regime to transactions that are carried out solely in fiat currencies (i.e., regulated currencies such as the Canadian dollar). As such, transactions made with bitcoin and other digital currencies fall outside of the scope of the regulatory regime unless there is other ancillary activity offered by PSPs that falls within the scope of the core functions.
Given its broad scope in this way, the regulatory regime will regulate the newer players in the retail payments ecosystem, such as fintechs and other currently unregulated PSPs. In light of the structure of the Canadian Constitution, the one question that remains unanswered is whether the federal government actually has the constitutional authority to regulate retail payments.
In that regard, in the Supreme Court of Canada judgment Reference Re: Securities Act, the Supreme Court held that the regulation of securities did not fall within federal power over general trade and commerce, and instead fell within provincial power of property and civil rights in the province. It remains to be seen if this proposed regulatory regime will be subject to similar constitutional challenges.
The regulatory regime proposes a registration requirement for PSPs. For existing PSPs (except those entities that only support the delivery of payment functions as suppliers for another PSP) registration will be required when the oversight framework comes into force. For new PSPs, registration will be required before any payment services are launched.
As part of the registration process, an applicant’s owners and directors would be required to undergo a criminal record check. More importantly, the applicant would also be required to be in compliance with the Proceeds of Crime (Money Laundering) and Terrorist Financing Act and related regulation (PCMLTFA).
This requirement is a significant one because PSPs transacting with Canadians are not necessarily subject to the PCMLTFA. It is unclear if this requirement is meant to be an indirect requirement for all PSPs to become subject to money laundering legislation or whether it is only intended to apply to those PSPs that are already subject to the PCMLTFA in respect of their business. In addition, the requirement to be “in compliance with the PCMLTFA” is quite broad. For entities regulated under the PCMLTFA, full compliance with every provision of the PCMLTFA is ideal but not realistic.
It is notable that the proposed regulatory regime provides the regulator with the ability to deny or revoke the registration of a PSP with the Financial Transactions and Reports Analysis Centre of Canada (FINTRAC) if it has been penalized for a “very serious” violation or, in the case of a money services business, if it is not registered with FINTRAC.
This regulatory power is one that is somewhat concerning for numerous reasons. As a starting point, it imposes on PSPs that are subject to the PCMLTFA, a different set of requirements than on other PSPs that may not be subject to the PCMLTFA. In addition, the result of this provision is that the regulatory standard for PSPs would be different than the regulatory standards imposed on financial institutions providing the same types of services. More importantly, it is not uncommon for an organization to be found to have committed a “very serious” violation under the PCMLTFA. This is partially due to the fact that, in the context of the requirement to file suspicious transactions reports (the failure to file of which is defined to be “a very serious” offence), the analysis of whether such a report was in fact required to be filed is made by FINTRAC in hindsight and, in our experience, is often made on a subjective basis. The ability of FINTRAC to effectively disallow a PSP from carrying on its business in Canada is not something that is contemplated in the PCMLTFA; that is why there are administrative and monetary penalties.
The regulatory requirements being considered to address financial, operational and market conduct risk include the following:
End-User Fund Safeguarding
It is proposed that PSPs will be required to place end-user funds held overnight or longer into a trust account with a Canadian financial institution. While this requirement seems fairly straight forward and uncontentious, it has two significant ramifications. Firstly, by requiring PSPs to have a trust account with a Canadian financial institution, they will likely become subject to the PCMLTFA as a money services business (which may be intended). Secondly, and more significantly, it is difficult for a money services business to obtain banking facilities in Canada. By making a Canadian bank account a requirement of the regulatory regime, it will disqualify many PSPs who are unable to obtain Canadian bank accounts from offering their services in Canada, thereby effectively hampering competition, contrary to one of the stated goals of the regulatory regime.
PSPs that perform any of the five core payment functions will be required to comply with security and operational objectives as well as with business continuity planning objectives to address operational risks. The basic principles that will apply in this regard include the following:
- Establishing a robust operational risk-management framework with appropriate systems, policies, procedures and controls to identify, monitor and manage operational risks.
- Defining the roles and responsibilities at a management level for addressing operational risk and endorsing the PSP’s operational risk-management framework. Systems, operational policies, procedures and controls should be reviewed, audited and tested periodically and after significant changes.
- Having clearly defined operational reliability objectives and policies in place that are designed to achieve those objectives.
- Having comprehensive physical and information security policies in place that address all major potential vulnerabilities and threats.
- Having business continuity plans in place that address events posing a significant risk of disrupting operations.
- Protecting end-users’ information and payment data and enabling the recovery of accurate data following an incident.
- Identifying, monitoring and managing the risks that end-users, participants, other PSPs and service and utility providers might pose to operations and to others.
As part of the operational standards requirement, PSPs would be subject to operational system testing to ensure an appropriate level of data protection. Such testing is contemplated to be conducted through a self-assessment in the case of smaller firms, or through third-party verification, in the case of larger firms.
PSPs that have a direct PSP/end-user relationship will be required to provide end-users with mandated disclosures presented in a clear and simple manner on the service or product being obtained, as well on the customer’s and PSP’s responsibilities.
The Consultation Paper sets out specific details on the proposed disclosures, including the specific content and timing of the disclosures.
In addition to required disclosures, the proposed regulatory regime provides for a mandatory dispute resolution process. As such, PSPs are required to have internal complaint handling processes and a designated external complaint body responsible for receiving complaints that fail to be resolved through the internal complaint handling processes.
The Consultation Paper provides details on the required elements of a PSP’s complaint handling process:
- The PSP must have appropriate capacity to respond to complaints
- The senior management team must be committed to having an efficient, timely and impartial complaint handling process and deploy the resources necessary to achieve it
- A senior officer within the organization must be designated as responsible for complaint handling
- Officers must also be designated to receive and deal with complaints
- Clients must be provided with a free and easily-accessible complaint process
- The complaint handling process must be reviewed and audited with a view to making improvements if required.
Similar to the requirements imposed on federally regulated financial institutions, the proposed regulatory regime provides for the designation of an external complaint body (ECB) that would provide an additional recourse for consumer/PSP disputes that cannot be resolved through the PSPs’ internal complaint handling processes. PSPs would also be required to provide the regulator with aggregate data about complaints on an annual basis.
PSP Liability for Unauthorized Transactions and Errors
The regulatory regime contemplates that payors would not be held liable for losses due to unauthorized transactions or errors unless they acted fraudulently or failed to fulfil certain obligations.
This limitation of liability would not apply where the payor:
- Has not taken reasonable care to protect the security of their passwords
- Has not notified the PSP, without undue delay, that a payment instrument has been lost or stolen, or that a password has been breached
- Has entered the payee information incorrectly such that it was impossible for the PSP to transmit the funds to the right payee. Under this scenario, the PSP would have to make reasonable efforts to recover the funds.
The Proposed Framework also contemplates the creation of an advisory service intended to do the following:
- For small PSPs that are new to the market and may have limited resources, assist them in understanding the regulatory framework and help them navigate the regulatory landscape in a timely and cost-effective way
- Guide qualified registrants who may be less sophisticated in dealing with regulators through the registration process
- Assist registrants by interpreting the various framework requirements having regard to the PSPs specific business models.
The comment period is open until October 6, 2017. All PSPs that would be affected by the new regulatory regime should consider providing comments to the Department of Finance to ensure that they have a voice in the process.