The government has published for consultation the draft Payment Services Regulations 2008, which will implement the Payment Services Directive (the Directive) in the UK with effect from 1 November 2009 (see ‘Implementation of the Payment Services Directive: a consultation on the draft legislation’, July 2008). The deadline for responses is 3 October 2008.
In December 2005, the European Commission proposed the Directive with the aim of achieving a single market in retail payment services, to give providers fair and open access to payments markets and increase protection for consumers.
The Directive, which was adopted by the European Council and the European Parliament in November 2007, has two main components:
- an EU-wide licensing regime for non-credit, non-e-money institutions (payment institutions), which will allow providers to offer their services throughout the EU on the basis of a licence obtained in one EU Member State; and
- harmonised conduct of business rules for all EU providers of payment services, including pre- and post-contract information requirements and rights and obligations of providers and users.
In looking at the Regulations, the first step that an institution must take is to establish whether it performs any activities that fall within the definition of payment services. If it does, and it cannot benefit from the exemption available to small payment institutions:
- it will need to apply for FSA authorisation as a payment institution, unless it is already authorised as a bank or e-money issuer;
- if it needs to become authorised as a payment institution, it will need to hold appropriate capital;
- it will need to comply with the prior and post-contract information requirements of Part 5, unless it can and wishes to contract out of relevant provisions (for which see further below); and
- it will be subject to the rights and obligations of Part 6, unless, as in (iii) above, it can and wishes to waive certain of those provisions.
The question then arises – what is a payment service? Payment services are listed in Part 1 of Schedule 1, but working out what is meant is not quite that simple. The main challenge is in the definitions, in particular the definitions of ‘payment account’ and ‘payment transaction’, which could in theory encompass a number of financial products that do not involve payment services as the term is commonly known.
Regulation 2 defines ‘payment account’ as ‘an account held in the name of one or more payment service users which is used for the execution of payment transactions’. In turn, a ‘payment transaction’ is defined as ‘an act, initiated by the payer or payee, of placing, transferring or withdrawing funds, irrespective of any underlying obligations between the payer and payee’. It is clear from this that current accounts fall squarely within the scope of the Regulations, as they are precisely the type of payment accounts the Directive is intended to regulate, but the potentially wide ambit of these definitions raises the question of whether the operation of various other types of accounts is equally caught. Amongst these are savings accounts, client money accounts, mortgage accounts, margin accounts, brokerage accounts and securities clearing and settlement services. The Directive does not elaborate, nor does Treasury, so one is left to read the Commission’s questions and answers page on the subject, which is the latest means of accessing, and to some extent influencing, the thinking behind European legislation (see http://ec.europa.eu/internal_ market/payments/docs/framework/transposition/ faq-2008_07_23_en.pdf).
From that page, one learns that the Directive is not intended to regulate credit accounts such as standard mortgage accounts established by the mortgage lender in conjunction with a mortgage loan on a residence into which the borrower is required to make regular and periodic payments. This is because, in relation to those accounts, the institution holding the account is not acting as a payment service provider, but as payee. The answer is different if the account combines the loan and some other savings and/or payment functionality, like a one-account.
Securities and clearing services are outside scope by virtue of the exemption in Article 3(h). On the other hand, the Commission argues that, at least in principle, ordinary savings accounts fall within scope, insofar as they allow the holder to place and withdraw funds without additional intervention or agreement of the payment service provider, whereas fixed-term deposits are outside scope precisely because they lack any such flexibility.
Initially the Directive was intended to apply to payment transactions made in any currency where at least one of the payment service providers was located in the EU, known as the one-leg out approach. On a rethink, Europe decided that this was too ambitious and/or unachievable, in particular in relation to the apportionment of rights and liabilities, and so the Directive was restricted to payments made in an official currency of a Member State where both payment service providers are located in the EU.
There are now two exceptions to this rule. The first, which is not an exception per se, is that institutions are being encouraged to consider applying the Directive on a voluntary basis to one-leg out transactions. Despite the obvious difficulties in agreeing to comply with more onerous requirements than one would normally be obliged to do, applying the Regulations to an institution’s provision of payment services as a whole, regardless of currency and origin or destination of the funds, may have its advantages in the areas of systems and controls and client-facing documentation. After all, it might be simpler to apply the same standards to all transactions of a particular type, without having to enquire about territoriality.
However, beware – some of the requirements may be challenging, if not impossible, to satisfy where the payment originates outside the EU. For example, if you are the payee’s payment service provider receiving a payment from outside the EU, how easily would you be able to provide your client with a reference to allow it to identify the payment and the payer and the exchange rate used, especially where conversion has been effected by the payer’s payment service provider (Regulation 43(2))? Besides, if you are already operating with different sets of documentation in any event (for example, because of the way in which you have decided to treat corporates), then the advantages of simplicity and consistency across the business may disappear altogether.
The second exception, reflected in Regulation 75, is that the value dating provisions will apply on a one-leg out basis (see Regulation 53(2)). The value date is essentially the time from which interest is credited to or debited from a payment account. Regulation 75 provides that the credit value date for the payee’s payment account must be no later than the business day on which the amount of the payment transaction is credited to the account, and the debit value date for the payer’s payment account must be no earlier than the time at which the amount of the payment transaction is debited from the account.
Regulation 75 also provides that the payee’s payment service provider must ensure that the amount of the payment transaction is made available and is at the payee’s disposal immediately after that amount has been credited to the account of the payee’s payment service provider. This raises one obvious question – when is it that an amount is credited to an account, especially in the case of cross-border transactions, for example where a correspondent bank intermediates receipt of the payment?
Part 5 of the Directive, which implements Title III, sets out the information that payment service providers must make available to payment service users before and after the conclusion of single payment transactions. It also sets out the content requirements for framework contracts, which are essentially the Directive’s way of describing an institution’s terms of business for dealing with clients to whom it provides payment services.
In principle, nothing in the Regulations mandates that payment service providers re-document framework contracts existing on 1 November 2009 to comply with the prescribed content requirements. However, by virtue of Regulation 40, it is likely that all players in the industry will choose to amend terms of business with existing clients, as not doing so would have the undesirable effect of forcing institutions to comply with information requirements for every single payment transaction completed after that date.
A word of warning though – when amending existing terms of business, institutions must be alive to the fact that they may unintentionally import onerous Directive obligations into non-Directive areas of the client agreement. It would be far from ideal to find oneself in the position of having to give clients two months’ notice of any proposed change to, say, one’s terms and conditions for conducting investment business simply because, by amending documentation to comply with the Directive’s requirements, the institution had created an overarching framework contract encompassing the entire client relationship, which had in turn become subject to Regulation 45 (Regulation 45 implements Article 44). It is therefore worth considering whether it is possible to split out the payment service aspect from the rest of the relationship, although of course here again institutions may be faced with having to choose between the lesser of two evils, as there are cost, systems, and perhaps treating customers fairly implications of handing out different pieces of paper to the same client.
Impact on products
Among the many challenges presented by the Regulations, one aspect of the interplay between Regulation 45 and Schedule 5 is particularly puzzling, especially as it may impact on product design.
Schedule 5, which implements Article 42, sets out the content requirements for framework contracts. Paragraph 3(b) provides that the framework contract must disclose ‘where relevant, details of the interest and exchange rates to be applied or, if reference interest and exchange rates are to be used, the method of calculating the actual interest and the relevant date and index or base for determining such reference interest or exchange rates’. Paragraph 3(c) then provides that, if agreed, the framework contract must also explain that changes in reference interest or exchange rates will apply immediately in accordance with Regulation 45(5). A reference interest rate is the interest rate which is used as the basis for calculating the interest to be applied and which comes from a publicly available source verifiable by both parties to the contract (see Regulation 2). In other words, a rate like LIBOR.
Regulation 45, which implements Article 44, requires payment service providers to give payment service users two months’ notice of any proposed changes to the existing terms of a framework contract, together with the right to terminate the contract immediately and without charge if the user does not wish to be bound by the change. One exception to this rule is in relation to interest rate changes, which can take effect immediately and without prior notice to the payment service user in two cases:
- where the change is more favourable to the user; and
- where the change is based on a change to the reference interest rate disclosed in the framework contract and the framework contract provides for immediate application of any such change in accordance with Schedule 5.
It is clear from these provisions that the payment service provider can ensure, for example, that it is entitled to benefit immediately from a change in LIBOR without having to give prior notice to the user. However, what is less clear is the position of variable rate products that are either not based on a reference interest rate or are based on such a rate plus an unspecified variable margin.
This raises several questions. First, will the requirement to give two months’ notice of changes mean that in practice institutions will be less willing to offer nontracker products? Second, will institutions continue to be entitled to charge an unspecified variable margin above a reference rate, or does the requirement to disclose the method of calculation of the actual interest under paragraph 3(b) of Schedule 5 mean that only a specified fixed margin can be charged? Third, is the payment service provider entitled to increase, or only to lower, any specified fixed margin without complying with the notice requirements?
The industry and their legal advisors will need to think carefully and creatively around these issues to avoid an undesirably harsh, and assumingly unintended, impact on product design.
Dealings with non-consumer clients
Regulations 37 and 53 allow providers and users to agree to waive certain provisions of Parts 5 and 6, which implement Titles III and IV, where the user is not a consumer. These waivers are particularly relevant to institutions that deal with corporates that fall outside the definition of a micro-enterprise.
The question here is what the Regulations mean by agreement. Do they require express consent or consent by conduct, ie will providers need to obtain clients’ signatures to the waiver, or will it be sufficient for an institution to rely on the fact that, on being informed of their classification as corporates not entitled to benefit from these protections, clients continue to do business with the institution?
One further point to consider is that old question of how advantageous it is in practice to apply double-standards, ie to use different systems and to have different sets of documentation depending on who the client is, especially as in relation to payment services a provider may find that it is dealing with a lot of different groups of users attracting different requirements. There will be consumers to whom all of the Regulations apply; there will be corporates who have agreed to waive certain provisions; there will be corporates who have not; and then there will be micro-enterprises, which are a category in their own right. Institutions may decide that it is easier to apply the Regulations across the board to everyone to whom they provide payment services.
Treatment of micro-enterprises
A micro-enterprise is defined as an enterprise which, at the time at which the contract for payment services is entered into, employs fewer than 10 persons and whose annual turnover and/or annual balance sheet total does not exceed €2m (see Regulation 2 and Articles 1 and 2(1) and (3) of the Annex to Recommendation 2003/361/EC of 6 May 2003). Regulation 37(5) provides that a payment service provider may require the payment service user to inform it:
- at the time at which it enters into the contract for payment services, that it is a micro-enterprise; and
- at any time during the contractual relationship, of any change in status resulting in it no longer being a micro-enterprise.
Sub-paragraph (i) is intended to reduce the onus on payment service providers to carry out due diligence on every client to establish whether or not it fulfils the criteria that brings it within the definition of a micro-enterprise. The provider can simply shift that onus on to the user by inserting a suitable clause into the framework contract. Sub-paragraph (ii) is an extension of that – it does not matter whether a user becomes a micro-enterprise later in the client relationship, as the Regulations suggest that the relevant point in time at which the user can benefit from being classified as a micro-enterprise is ‘the time at which the contract for payment services is entered into’, ie the beginning of the relationship. However, it is relevant for the provider to know whether the user, who is initially classified as a micro-enterprise, later becomes just an ordinary corporate.
And why does it matter whether a user is a micro-enterprise or just an ordinary corporate? Because the UK has decided to make use of the derogations in Articles 30(2) and 51(3) that allow Member States to require payment service providers to treat micro-enterprises as consumers. So, if a corporate tells a payment service provider that it is a micro-enterprise, the provider cannot agree with it to waive provisions of Parts 5 and 6 as it can do with other corporates – it has instead to apply the Regulations to the relationship with that corporate as a whole.