How effective is the market for the supply of indirect access to payment systems?

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The Payment Systems Regulator (PSR) recently published its interim report and proposed next steps on its market review into competition in the supply of indirect access to payment systems. The PSR’s interim conclusion is that work to open up access to payment systems is generating increasing positive results. Although the PSR identified several concerns around choice, service quality and the ability to switch providers, it proposes to wait 12 months to determine whether current/ongoing initiatives address these concerns rather than taking immediate regulatory action.

The Payment Systems Regulator

The PSR is a recently established independent regulator, a subsidiary of the Financial Conduct Authority, charged with responsibility for the regulation of payment systems – the services that enable the transfer of funds between people and institutions. In essence, as the PSR notes in its interim report, its aim is to ensure that payment service providers (PSPs), such as banks, building societies, credit unions, payment institutions and e-money institutions, can access payment systems without facing anti-competitive barriers or unnecessary burdens.

The PSR is empowered to conduct market reviews using information-gathering powers under section 81 of the Financial Services (Banking Reform) Act 2013 or using concurrent competition law powers under the Enterprise Act 2002. In undertaking the market review into the supply of indirect access to payment systems, the PSR has used its section 81 powers.

Focus and terms of reference of the market review

The PSR announced the market review in March last year. 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 relation to contractual arrangements in place between indirect access providers (IAPs) and indirect payment service providers (IPSPs). The payment systems of particular focus in the report are Bacs, CHAPS, Cheque and Credit Clearing, and Faster Payments Service.

The final terms of reference identified the key questions that the PSR intended to examine:

  • What prices, service and choice do IPSPs want and receive?
  • What factors may limit the number of IAPs in the market?
  • What is the state of competition in the provision of indirect access?
  • What options are there to improve indirect access to interbank payment systems?

The interim report – market overview

The market is characterised by PSPs who provide services that enable the transfer of funds. Access to the various payment systems can either be direct, if the PSP has an arrangement with the payment systems operator, or indirect, if it has a contractual arrangement with an IAP. IAPs may also be direct payment systems providers (DPSPs) themselves, which the PSR considers may have the potential to adversely affect competition in the downstream market.

A decision to access payment systems directly or indirectly will, according to the PSR, depend on a number of factors including volume of transactions, the complexity and scale of the transactions and eligibility. Of these, eligibility is a particularly important factor.

The PSR has identified two different types of IPSPs – agency IPSPs and non-agency IPSPs. The former are provided with one or more unique sort codes by their IAP and comprise primarily banks and building societies. The latter are not provided with unique sort codes by their IAP. Non-agency IPSPs generally provide payment services not related to the provision of payment accounts, such as money remittance and card acquiring. The PSR found that there are approximately 300 IPSPs and over 2,000 non-agency IPSPs.

The PSR found that IPSPs receive indirect access services alongside other banking services and indirect access service is not a significant revenue generator for IAPs on a stand-alone basis.

The PSR concluded that competition in the supply of indirect access is producing some positive outcomes, notably:

  • large IPSPs have a variety of options to access payment systems
  • there is a substantial level of overall satisfaction with the quality of the indirect access offering that IPSPs receive
  • there does not appear to be a widespread level of concern with regard to price, although large IPSPs tend to pay relatively lower prices
  • there is evidence of investment and innovation in new and improved service offerings, which should lead to better quality services and more choice for all IPSPs.

Limits on competition and innovation

However, the PSR has identified some specific concerns that limit competition and innovation in the provision of payment services, including:

  • limited choice for small non-agency IPSPs. While large IPSPs have a wide choice of access options and negotiating power, including direct access for large agency IPSPs and the ability to issue invitations to tender for their custom, smaller non-agency IPSPs do not have the same negotiating power and may suffer as a consequence
  • there are some quality issues. Banks and building societies have concerns about the quality of technical access to the new Faster Payments Service (FPS). Small non-agency IPSPs have concerns about notice periods for the termination of indirect access agreements, which can range between one and three months – which can result in difficulty finding alternative suppliers. The PSR found that the relationship agreement can vary between customers, leading to a lower quality of service for smaller IPSPs, which can impact their ability to compete in related markets, such as retail banking
  • historically low levels of market entry and expansion. On the other hand, the PSR considers that market developments may see an increase in the number of IAPs in the not too distant future – for example, the PSR noted that at least 15 respondents indicated an intention to become DPSPs in the next three years, which may increase the number of IAPs
  • concerns regarding financial crime exposure, and regulation and monitoring costs, can lead to IAPs imposing greater restrictions and eligibility criteria on smaller IPSPs or IPSPs with particular business models
  • low switching rates for both agency and non-agency IPSPs, with many IPSPs having maintained their existing IAP relationships for at least five years and nearly 50 per cent of respondents having maintained the same relationship for over ten years. Switching rates are particularly low for agency IPSPs, who have to conduct significant tender and due diligence exercises, develop new IT connections and incur significant time and expense communicating with consumers if they do switch suppliers.

Current or anticipated developments that may improve access for service users

The PSR has identified a number of current/impending developments which can be expected to improve choice, quality and price outcomes for service users:

  • the PSR’s programme of work on direct access
  • likely market entry and expansion
  • improved IAPS access offerings for access to FPS
  • development of the Image Clearing System
  • the Bank of England’s strategic review of its real-time gross settlement infrastructure
  • IAP Code of Conduct
  • information-related initiatives (e.g. the PSR’s Sponsor Bank Information Direction and the industry information hub should facilitate switching by increasing transparency and reducing the search costs for IPSPs).
  • reviews of financial crime regulation
  • Payments Strategy Forum
  • the Competition & Markets Authority’s proposed measures to improve switching as part of its Retail Banking Market Investigation
  • Current Account Switch Service.

The PSR’s current thinking is to support these initiatives rather than taking immediate regulatory action. The PSR considers that further regulatory action may adversely impact the incentives for current developments, in particular the development of improving the switching process in relation to IAPs. The PSR indicates that if its concerns are not addressed during the next 12 months, it has outlined a number of steps it could take, including:

  • forcing some or all indirect PSPs to act as IAPs
  • requiring IAPs to satisfy 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 service easier, or the switching process better.

Next steps

The PSR is inviting comments on its initial report until 5 May 2016. The PSR anticipates publishing its final report in summer 2016. If there are areas where commercial terms for access to payment systems could be improved, now is the time to bring the matter to the PSR’s attention.