Innovation in Payments - Consequences of Disintermediation

Innovation is set to fundamentally change the payment ecosystem. Recent developments, such as instant payments, e-money, stablecoins and more, present serious competitive threats to traditional payment service providers and their ability to remain the system of choice for consumers and businesses. Additionally, the regulatory framework, which has developed alongside the traditional payment ecosystem, may not adequately mitigate the potential risks posed by these new forms of payments. Incumbents must work towards a smooth transition through these payment innovations, as this is critical to financial stability and to securing their place in this new matrix.

A new payment chain

Payment innovation is likely to challenge incumbents by reimagining the payment chain, i.e. the set of activities necessary for a payment to be made. This chain typically comprises banks, a small number of systemic payment systems, e.g. TARGET2, and card schemes such as Visa or MasterCard. However, recent payment innovations have led to the process of electronic payments becoming increasingly disintermediated. In other words, the payment chain may now start with new non-bank entities using new technologies at the point of initiation, such as digital wallet providers that allow mobile phone payments, or technology aggregators that process a merchant’s online transaction for them without needing a merchant account at a bank. Other technological developments, such as stablecoins (e.g. Facebook’s Libra), could also fundamentally change the way payments function, taking over a large share of retail payment systems, to the detriment of existing service providers. Understanding the challenges these innovations pose is the first step towards an incumbent remaining the service provider of choice. 

Regulation focused on risk

These changes in the payment chain will in turn affect the current regulatory framework, which could be argued to be inadequate at this point in time. Due to technological developments moving at a much faster rate than legislation, regulators may move away from this system where an entity is regulated depending on its nature, towards one in which is regulated depending on the level of risks it poses. In other words, regulation of payments will reflect the financial stability risk, rather than the legal form of payments activities. This would cover the entire chain end-to-end. This argument was put forward at a recent speech by Steven Maijoor, ESMA Chair, stating ‘Even where these components do not meet the relevant legal definitions, they should be regulated in line with the risks they raise’.

Next steps

Regulation needs to facilitate innovation and the protection it provides should not depend on how consumers are paying, whether it’s cash, card or stablecoin. The focus should be on imposing the same requirements for the same risks. With this in mind, it is very timely that the UK Government’s Budget 2020 announced a call for evidence for the Payments Landscape Review. The HM Treasury, working alongside the regulators and the Financial Policy Committee, will be leading a Payments Landscape Review to make sure the UK’s payments infrastructure and regulation are keeping pace. As part of this, HM Treasury will shortly be publishing a call for evidence to ask what more could be done by the government, industry and regulators. There is also the Bank of England Discussion Paper on a possible Central Bank Digital Currency, which could present opportunities for maintaining monetary and financial stability.

Such initiatives will aid policymakers in identifying the issues mentioned above and how to better support a more innovative and resilient payments system, ensuring the UK payments sector remains world leading.