On 10 March 2016, the Payment Systems Regulator (PSR) published a report setting out its interim findings from its market review into competition in the supply of indirect access to payment systems (the Report). For more information on the subject matter of the review see our previous briefing, PSR confirms terms of reference and timetable for its first market review into indirect access.
What is indirect access?
Payment service providers (PSPs) need access to payment systems in order to be able to offer payment services to their customers and compete effectively. PSPs can access payment systems directly, by contracting with the operator of the payment system (direct PSPs). Alternatively, PSPs can access payment systems indirectly (indirect PSPs), by contracting with direct PSPs.
Indirect PSPs can be either “agency” or “non-agency” indirect PSPs. Agency indirect PSPs will be provided with one or more unique sort codes from their Indirect Access Providers (IAPs) and are the main providers of payment accounts (usually current accounts) to customers. Non-agency PSPs are not provided with a unique sort code and tend not to provide payment services related to payment accounts, instead providing services such as money remittance and card acquiring.
Indirect access is key to a large number of PSPs, particularly those that are not eligible, or do not want, to be direct participants. The supply of indirect access services is therefore crucial to effective competition in the retail banking and payments markets.
Focus of the review
The aim of the review is for the PSR to get detailed evidence to develop a deeper understanding of the supply of indirect access, principally in respect of the contractual arrangements in place between IAPs and indirect PSPs. The payment systems of particular focus in the Report are Bacs, CHAPS, Cheque and Credit Clearing (C&C), and Faster Payments Service (FPS).
The PSR’s interim findings
The PSR’s interim findings conclude that competition is working sufficiently well to produce good outcomes for indirect PSPs and their customers. However, the PSR has identified particular areas of concern where competition is more limited and can result in unfavourable outcomes, such as:
- issues with the quality of service all indirect PSPs receive for indirect access
- the limited choice of IAPs, which particularly affects small non-agency indirect PSPs
- barriers preventing all indirect PSPs from switching to alternative providers.
It proposes to keep these issues under review for the next 12 months.
Choice, service quality and prices
Competition is working better for larger indirect PSPs because they have a wider choice of IAPs through which to access payment systems. These PSPs are more likely to exercise choice, thereby exerting competitive pressure on the IAPs supplying them. Competition is working less favourably for small non-agency indirect PSPs and their customers, which have a much more limited choice of IAPs. That lack of choice contributes to those PSPs having relatively weak bargaining positions and drives less favourable outcomes for their customers.
The Report also notes that the quality of service provided by IAPs can adversely affect the ability of indirect PSPs to provide their customers with better outcomes and thus to compete effectively. Whilst the Report suggests that there is a “reasonable” level of satisfaction amongst indirect PSPs with the quality and level of service provided by IAPs, the PSR has evidence of service quality issues experienced by all types of indirect PSPs1. Smaller non-agency indirect PSPs that tend to access payment systems through the online banking systems of their IAP appear to be the least satisfied. The PSR is, however, encouraged by the level of investment and innovation in respect of new and improved service offerings and considers that this should, in turn, go some way to improving the quality and choice outcomes for all indirect PSPs.
The PSR has not identified any widespread concerns about price, but suggests that this may be because it has been difficult to assess and compare the pricing information it has received (which often relates to a wider commercial relationship) to arrive at any definitive conclusions.
Factors affecting the number of IAPs
The Report identifies a number of market characteristics that have historically made becoming an IAP unattractive, thereby restricting the choice of IAPs available to indirect PSPs. These include regulatory and compliance requirements, which usually increase the risk and costs burdens on IAPs; uncertainty as to future levels of demand for indirect access and low switching rates, meaning it is difficult to attract new customers; the low revenues associated with these services (unless they are part of a wider package); and the investment required in technology and staff.
However, the PSR is aware of four potential entrants planning to become IAPs, and two existing IAPs looking to expand and improve their indirect access offering in the next one to two years. It considers that this new entry and expansion is likely to address many of its concerns relating to the limited number of IAPs.
Behavioural factors that influence competition in indirect access provision
The PSR’s view is that the provision of indirect access is affected by the costs and risks associated with financial crime (in particular, money laundering and terrorist financing). Consequently, some IAPs have introduced minimum revenue thresholds for new indirect PSPs and have introduced de-risking policies, whereby access for higher risk customers has been terminated. Small non-agency PSPs have been particularly affected by this. The interest in attracting new customers varies from one IAP to another, but generally speaking, smaller non-agency PSPs are seen as the least attractive.
There are low switching rates among all indirect PSPs, which the Report suggests is largely due to concerns about disruption of services. Switching for agency PSPs is also constrained by the difficulty of transferring sort-codes. Those indirect PSPs that have fewer choices of IAP (especially small non-agency indirect PSPs) may not be able to obtain the services they need and have limited bargaining power, which may dampen competition and lead to less favourable outcomes for service-users.
The PSR’s proposals
At this stage, the PSR is not proposing to take any action. There are numerous current/ongoing commercial, regulatory and technological developments, including the PSR’s own measures, that it considers need time to bed-down, such as:
- the recently published IAP Code of Conduct, which already sets out a range of measures with the aim of improving indirect access2
- the PSR’s general programme of work on direct access, which aims to make it easier to become a direct PSP and its directions that require sponsor banks to publish access-related information
- the emergence of alternative direct technical access models for interbank payment systems
- the development of the Image Clearing System for cheques, which aims to make sort-codes fully transferable and improved the ability of agency indirect PSPs to switch IAP
- work being done by the Payments Strategy Forum3 which is considering how to improve access, prevent financial crime and reduce compliance costs
- the various reviews of financial crime that are ongoing
- proposed measures to improve switching as part of the Competition and Markets Authority’s Retail Banking Market Investigation
- the Bank of England’s strategic review of its settlement account policy.
If, during the next 12 months, the PSR’s concerns are not addressed, it has outlined a number of steps it could take, including:
- forcing some or all direct PSPs to act as IAPs
- requiring IAPs to satisfy specific minimum quality standards and termination notice periods
- requiring all direct members of FPS to provide an equivalent quality of service and price to indirect PSPs as is given for their own downstream activities
- setting a specific, or maximum, price for indirect access, or imposing other pricing controls
- various measures to make comparing IAP services easier, or the switching process better.
What this means for you
The market for indirect access is complex and dynamic. It is currently undergoing substantial change. In light of this, it is perhaps unsurprising that the PSR has decided not to intervene further in the market at this stage: the PSR will be reluctant to impose further regulation, which could tip the balance and cause existing or new entrant IAPs to reconsider the benefits of offering these services, particularly given the low revenues generated by supplying indirect access in isolation to smaller PSPs (as compared to supplying indirect access as part of a wider, more profitable commercial relationship).
For now, the PSR appears to consider that there is sufficient entry and expansion in the market to address its concerns: it will be interesting to see whether respondents to the consultation agree with the PSR’s conclusions. Should the PSR decide, either at final report stage or beyond, that regulatory intervention is required, it will need to consult on such proposals. Stakeholders have until 5 May 2016 to respond to the PSR’s consultation. The final report will be published in summer 2016.