The Cat Is Out Of The Bag: The EU Bars UK Financial Outsourcing

A key EU financial authority has asked EU regulators to be strict on UK firms seeking to escape the impact of Brexit. The concern is that having lost their EU passporting rights, desperate Brits will try to get authorised in Europe but continue to rely on UK managers and operations. 

"UK-based market participants may seek to relocate entities, activities or functions to the EU27 in order to maintain access to EU financial markets. In this context, these market participants may seek to minimise the transfer of the effective performance of those activities or functions in the EU27, i.e. by relying on the outsourcing or delegation of certain activities or functions to UK-based entities, including affiliates. It is therefore necessary to ensure that the conditions for authorisation as well as for outsourcing and delegation do not generate supervisory arbitrage risks."

ESMA even proposes a Cat o' nine tails set of 9 "principles" to prevent UK firms making the best of Brexit: 

1. No automatic recognition of existing financial firm authorisations;
2. Authorisation processes by the EU27 should be "rigorous and efficient";
3. Regulators must verify the objective reasons for relocation;
4. Regulators should avoid "letterbox" entities in the EU27 - the EU firm must perform substantial activities;
5. Outsourcing and delegation to third countries (like the UK) is only possible under strict conditions;
6. Substantive decision-making must occur in the EU, especially over outsourced activities;
7. There must be sound local governance of EU entities, by resident directors/senior managers;
8. Regulators must have the resources and data to effectively supervise and enforce EU law. 
9. ESMA is watching and will co-ordinate to ensure adequate and consistent supervision. 

Of course, the UK could retaliate with red tape of its own. Brexit is also a challenge for 8,008 EEA firms that hold 23,532 passports (about 3 each) to cover their UK offerings.

The Politics of Cash

Over on Tomorrow's Transactions, Dave Birch quite rightly questions the assertion in the NY Times that cash is somehow important to "protect our civil liberties by preserving some untraceable payment method." Few people are obsessed with anonymity. But at the same time Dave applauds the notion that "Cash-based economies harm the poor by heightening the risks they face when carrying money and fueling government corruption and inefficiency."

I should declare at the outset that I'm a great fan of electronic money and online financial services, and I advise various clients in the payments and online peer-to-peer finance space.  But I also believe that innovation doesn't 'kill' anything - the new must coexist with the old. Calling for the abolition of old services brings the laggards out in force, sometimes to comic effect. That's one reason you won't hear me calling for the end of fractional reserve banking.

But the 'death of cash' is not a question of civil liberties or somehow liberating the poor from a cash economy. Many people - the so-called 'unbanked' in particular - still see cash as the best mechanism for maintaining control over their finances. What some people see as higher prices for not paying online or by direct debit etc, others see as a wise investment in a payment method that prevents them spending money they don't have.

 

Research commissioned by the Financial Inclusion Taskforce found that the 3 million British adults without a bank account (the 'unbanked') do not consider themselves as disadvantaged by not having bank accounts, cheque books and debit cards. They do not see much use in an ATM, cheque book, credit card or debit card because they don't tell you your balance until it's too late. A text message confirming a payment you just made is laughable.

And if you don't find your bank or its services trustworthy or useful in the first place, why would you give them all your personal details so they can text your bank balance to your phone?

Most importantly, the same research found that most of the so-called 'unbanked' are actually in control of their finances. They put cash in specific jars to cover certain expenses. They can readily see at any time how much is in the jar, so they 'always know where they are' in setting money aside for energy bills and so on. 

I agree that loan sharks and others may prey on this form of financial control. But it's not as if access to a bank branch, internet banking or direct debit has saved the rest of us from financial charlatans or the erosion of civil liberties...

Long live cash, I say.

Regulatory Creep And Overkill For Closed Loop Payments

The Treasury reports that it received no support for its proposal for voluntary consumer protection codes for ‘closed loop’ or limited network stored value, which are exempt from European E-money regulation. These include store cards, coffee shop cards, fuel cards, transport cards, membership cards, and meal and other voucher systems - nothing like the collapsed retail pre-payment schemes that have previously lost their customers' money Farepak (Christmas hampers) and WrapIt (wedding gifts).

However, the rejection of the need for voluntary codes arguably opens the way for formal regulation, as the Treasury had seemed to be firmly of the view that more protection is necessary for the reasons summarized below. As a next step:

“The Treasury has asked the Office of Fair Trading (OFT) to provide some advice on the prepaid market, the effectiveness of current self regulatory solutions for protecting consumers, and the interaction between the regulated and unregulated sectors. This advice will be fully considered before the Government decides what, if any, action to take.”

Ominous? Well, it depends on what they mean by "prepaid". If the Treasury means retailers who require people to pay for products weeks or months prior to shipment, then I wonder why it's taken them so long to address a really obvious problem. But if they mean gift vouchers to make sure your nephew spends his birthday money on something educational instead of 5kgs of sweets, then this is over-kill.

I’ve extracted the summary of responses on this aspect below:

"3.10 There was little or no support for voluntary codes as a solution to improving the safeguards for consumers in the unregulated sector.

3.11 Responses fell into two broad categories: those that argued that tougher regulation and enforcement than voluntary codes is necessary to address perceived shortcomings in the unregulated sector; and those that felt that there was no justification for action due to the low risk of consumer detriment. The main reason for the general dissatisfaction with voluntary codes was that, although models vary, supervising and enforcing a voluntary code is often thought to be difficult. There are usually no limits to the number of violations a company might have, no financial incentive to abide by a code, and weak rights of recourse for consumers.

3.12 Some respondents argued that no action was necessary because the perceived risks are low. It was also argued that voluntary codes would be unworkable in practice because the average amounts outstanding on unregulated products (mainly gift cards) are less than £30. These responses concluded that the risk of loss per customer did not warrant a new protection mechanism."

Open-Loop Time Banks?

I spent Monday partly examining the practicalities of treating time as a currency at BarCampBank4.

In essence, 'time banks' for social care are no different to other closed-loop 'alternative' currencies ranging from loyalty schemes to gift card and store card programmes. Hureai Kippu, the Japanese system for earning the right to senior care by caring for senior citizens yourself, is often cited in this context. That specific model, which involves a nationwide clearing system for care credits, is being considered by various local authorities in the UK, though Age UK is among those who question its utility.

But we've had UK time-banking schemes since the '90s, e.g. TimeBank, TimebankingUK and Local Exchange Trading Systems or Schemes (LETS), the mutual aid barter network. The difference is explained here. So I it's clear there is something worthwhile that can be achieved by trading units of time to solve underfunded problems like personalised social care in its many forms.

However, we need to be cautious about 'open loop' time banks, even though this may bring welcome liquidity and funding to support an aging population with a giant pension deficit. There's a range of practicalities that stand in the way of time - or loyalty points, for that matter - becoming a 'real' or open-loop, freely negotiable currency or E-money. I'll cover these briefly below. But a more fundamental point is that I'm not even sure that opening up such currencies would add any utility to what's already feasible with any real currency, unless the underlying E-money system is somehow cheaper and more cost effective in moving money or other resources to where they are needed. And there are of course plenty of E-money systems that did not need to go to the trouble of creating a new currency to get going.

Other than funding the business itself, perhaps the main practical challenges to time banks becoming open-loop are achieving 'critical mass', enabling immediate redemption in cash, and tax. Issues of trust, privacy, data protection and so on seem secondary and surmountable so long as the upside to participating and disclosing information outweighs any perceived downside.

Achieving a 'critical mass' of people that will ensure adequate supply and demand for the type of time in question is an awesome challenge that deserves a post in itself.

The requirement for users to be able to redeem the time they have 'earned' or 'acquired' in cash at any time would go hand-in-hand with the need to be authorised as an E-money issuer, and to comply with various capital and prudential requirements, including safeguarding the cash corresponding to the outstanding time. Redemption in cash and safeguarding would seem to defeat the purpose of a time bank, founded as it is on the notion that participants deal only in time.

Finally, we are obliged to pay income tax on our earnings, as well as indirect taxes on sales of goods and services. And governments tend not to accept payment in anything other than their own national currency. While in a closed-loop UK time-bank for charitable purposes tax is not an issue, as soon as you enable redemption for cash or goods and services, tax would come into play.

For these reasons, I think time banks are very useful in allocating resources within a specific community, network or scenario, but not as an open-loop currency - at least not without substantial changes to the regulatory and tax framework.

Call for Self-regulation of Limited Network Payment Schemes

The UK Treasury is calling for self-regulation to ring-fence funds relating to stored value in “limited network” programmes, citing examples such as store cards, coffee shop cards, fuel cards, transport cards, membership cards, and meal and other voucher systems. The call is part of the Treasury’s consultation on the second E-money Directive which imposes similar obligations on the operators of 'general purpose' stored value programmes. While limited networks will remain exempt from E-money and payment services regulation, the Treasury will consider “whether further [regulatory] action is warranted” if what it sees as adequate self-regulation does not emerge. Consultation ends on 30 November.

Potential reasons cited by the Treasury for segregating limited network funds from operators' own corporate funds include:

• Apparent uncertainty as to the scope of the limited network exemption;
• A large number of consumers/businesses rely on limited network programmes and may suffer if programmes fail;
• A limited network failure may harm the reputation of other limited network programmes as well as regulated e-money providers; and
• Limited networks enjoy a cost advantage over regulated general purpose stored value programmes, partly through not needing to ring-fence funds equivalent to the outstanding stored value.

Whether each of these is really a problem is very much debatable. Guidance can clarify what is considered in or out of the regulatory scope, and the existence of 'grey areas' at the perimeter is no argument for definitively expanding the scope by requiring self-regulation. Of course, not all customers or businesses rely on all limited network programmes, or even the programmes of the same type. Similarly, the failure of one programme does not necessarily reflect on them all. That's clear from the collapse of retailers that entirely rely on pre-payment Farepak (Christmas hampers) and WrapIt (wedding gifts) which have provided the genesis for concern in this area generally, though neither was a stored value programme. Finally, why shouldn't there be cost advantages to running a programme whereby value can only be spent within a limited network, rather than one where stored value can be spent anywhere? The latter is always going to be much larger in scale and purpose, and entail far more operational risk.

While the evidence of detriment is less than clear, positive reasons not to introduce requirements to safeguard customer funds in limited network schemes include:

• The potential for additional requirements to be imposed in the course of the proposed self-regulatory exercise that needlessly increase the cost of operating the network;
• No one operating a dodgy scheme would sign-up for stringent self-regulation;
• It may be far more costly and onerous to ring-fence funds in certain types of limited network programmes than others, so some operators may be unfairly discriminated against by not signing-up on legitimate economic grounds; and
• Increased costs associated with self-regulation may result in fewer limited network payment programmes for customers to choose from and higher retail prices for customers overall.

A proportionate alternative might be to focus on improving the management of operational risk in businesses that rely entirely on pre-payment for specific items, as Farepak and Wrapit did. A nice, long chat with their auditors might also be in order...

Image from Newbusiness.co.uk

Buried!

Has a week gone already?! The distinct lack of posts has been due to my being buried by business-as-usual, plus:

• Consultations on the implementation of the new E-money directive by both the Treasury and the FSA;
• The latest edition of the EC's Consumer Markets Scoreboard;
• Excellent discussions on where bankers and social thinkers disagree and agree;
• All the other great stuff that I tweeted or retweeted, to which I may yet find the time to return; and
• Last but not least, agreeing the topic for discussion at the inaugural meeting of the SCL Junior Lawyers' Group on 20 January 2011 - be there!

Have a great weekend!

Image from PubSub.

Travels in the Blogosphere

Phew! What a journey, and what a pleasure to have so much great stuff to consider and comment on over the past week, including:

• the iPod of financial services on Guillaume's blog;
  

• the European Commission's e-money plans on panGloss;
  

• the EC's consumer protection plans on Digital Law;
  

• discovering that European Commissioner Meglena Kuneva has launched her own blog;
  

• the future of cash at Digital Money Forum; and
  

• the impact of prescriptive regulation on financial services innovation at The Bankwatch.

Thanks, folks, please keep it coming!

In the meantime, I reckon I'll need another week off...

Getting Your Tencent's Worth?

A great blog by Chris Skinner on QQ coins and their role in the future of money. The numbers are extraordinary indeed, leading me to wonder whether certain of the - ahem - "retailers" using the service aren't opening a unique account each time they issue QQ coins to fund a particular transaction?

One also wonders how well the service will weather the alleged Chinese government crack-down reported by Dark Diamond.

Somewhat nervously, I found it interesting to compare QQ coins to the characteristics that I told some RCA students would mark successful financial services innovation:

"1. The service is unlikely to be offered or facilitated by an entity that consumers perceive to be an “institution”;

2. The service solves the root cause of consumers’ critical need in the course of actual or desired activities, linking with trusted third parties to provide a comprehensive consumer experience;

3. The service leverages a shock amongst consumers who subsequently accept that the world has changed, yet helps them to embrace that change;

4. The service leaves day-to-day control of the management of money with the consumer;

5. The service improves rapidly with user collaboration, giving value beyond the facilitator;

6. The service will remain successful so long as the facilitator continues to invest in enhancing the service and meeting related consumer needs rather than seeking merely to enrich itself (i.e. preferring to meet the needs of stakeholders other than consumers);

7. The service is safe, easy to use, and involves communications that are fair, transparent (enabling ready comparison) and neither misleading nor patronising;

8. The service and its operator plays well with the regulators and public policy/opinion-formers."

I sense from Dark Diamond's numerous allegations that, if those allegations are true, QQ coins will prove a little rubbery in terms of 6, 7 and 8, pending the outcome of the alleged Chinese government intervention. But I guess PayPal weathered a similar kind of storm, and even eGold was entitled to remain in business, albeit subject to the laws it and certain of its directors had flouted.

So definitely worth watching that space, as well as how Tencent's western versions, like QQ Games are taken up.