Call to Action – Submit Response to Fed

1 Dec 2013

As most of you know, the Federal Reserve published a paper entitled Payment System Improvement and opened it for comments http://fedpaymentsimprovement.org/. Responses are due 13 days from Today. My response can be viewed here.

After witnessing the mess that Regulators and Central Banks can create (FFIEC 2 Factor Auth, UK Faster Payments, SEPA, …), you should take time to submit something for your organizations.  We all need a flexible regulatory environment which provides a fertile field for Innovation and technology evolution (of payments and banking).  How should the US payment system evolve? What is Broken? What is working? Who should lead (Government or Industry)? This is the context behind the survey which covers: tokens, real time payments, fraud systems, mobile payments, and approach.

Summary View

  • The Payment System works today for 95% of needs. Let’s NOT force everything to be real time. Just as we have Rail and Ship transport today… some consumers still demand next day air delivery (a business need that consumers will pay extra for).
  • The problem with the payment system is NOT speed, it is control. The American Banker article How Big Banks Killed a Plan to Speed Up Money Transfers speaks to the uneven playing field faced by small banks, MSBs and other service providers.  Why are big banks blocking this real time effort? Because the top 4 are formulating plans to restrict use of bank owned settlement infrastructure and create new semi-open REAL TIME settlement networks (ie ClearxChange) which will only work for the largest institutions (see New ACH Payment System for background on this initiative). The second paragraph of the Fed’s paper

    Industry adoption of new payment services and technology in this country has been driven mostly by market forces rather than government direction

    is incorrect. Industry adoption of CORE payment services is driven COMPLETELY by the top 5 banks. Top 5 Banks created and hold veto power over: Visa, MA, TCH, NACHA, … and most industry infrastructure.

  • There are only 2 regulatory changes I would request: #1 mandate transparency in rule making for both government controlled (FedWire) and private Payment Entities. No more anonymous voting on common infrastructure, the NACHA and TCH voting procedures are a mess.  The WSJ article above demonstrates the obfuscation.. and the subsequent success of this blog. #2 Allow non banks to assume risk and decrease compliance requirements (for banks) surrounding this service. (more on that later)
  • Over 40% of US consumers are no longer well suited for traditional banks and are migrating to new products (pre-paid/GPR cards) that are offered by new intermediaries. Payments are not only critical to the top of the pyramid but to the bottom. Non banks and the unbanked must be able to participate in the payment system. Again the issue is NOT real time payments, but ACCESS (control).
  • The core technical challenges in Payments are #1 Consumer Authentication, and #2 Risk Management. Non banks are best positioned to Authenticate a Consumer, and may also be best suited to manage risk (as Paypal does in Card Not Present). Banks bear the weight of KYC/AML requirements today and therefore look to control the entire process. If we want consumer centered investment, Non Banks must be able to participate, and bear risk. If the central bank commits to technology of yesterday  we will not be able to leverage new capabilities and consumer experiences will be highly fragmented. (ex a new Apple device which would enable real time, irrefutable transaction signing).
  • The core business challenges in payments today are around value. Banks do not want to invest in networks that benefit merchants (ie Debit, DDA) and Merchants don’t want to invest in networks that benefit banks (ie Credit, Contactless). Payments are just the last (easiest) phase of a long Commerce process. No one should force banks to invest in merchant friendly mechanisms, but banks should not be in a position to BLOCK success here.
  • There will be NO INVESTMENT, if there is NO RISK. Payment profitability is driven by risk management (including fraud, authentication, credit risk, …).  We must allow entities that can bear risk to participate and invest.
  • Network efficiencies MUST IMPROVE (see Thomas Phillippon below). The GOAL of payments should be to provide LEAST COST ROUTING to support consumer preferences of where and how they want to pay and authenicate (ex Apple, Google, …). Expanding an existing utility (ie Fed Wire) may provide a faster path to new capability, and develop a higher quality of service, as competition develops among private networks (analogy is Darpanet ).

MCI Interconnect in Financial Services?

The metaphor for change in the payment system may be the 80s MCI interconnect battle (see Wikipedia), combined with a new regulatory regime which would allow non-bank participation in an OPEN settlement network (Connection + Settlement). See my blog How to Deregulate Payments like Telecom. To understand the current state of industry quantitatively,  NYU’s Thomas Philippon published jaw dropping research detailing how Payments and Banking are one of the few network businesses in the HISTORY OF MAN to grow less efficient (rail, telecom, energy, …). Obviously Regulatory Capture is an issue as regulators protect Bank margins and discourage rate competition. The fundemantal flaw to the Fed survey is an underlying assumption that change will be made to existing utilities and existing players. I’d rather take the MCI approach where the government provides for open interconnect and allows other parties to assume risk. This is why Telecom, Airlines, Stock Exchanges, and the Internet work today. There will be no change, or new investment, unless Regulatory Capture and Big bank control over common utilities is broken.

In another example, from my blog Tokens – Merchant Options obviously there is a need to tokenize a direct draft ACH/DDA to hide the consumer’s account number. This is what the TCH upick system (bespoke TCH token system) was developed around. However banks have NO incentive to deliver innovation around DDA tokens as it would decrease risk and increase consumer adoption in a model where they can not charge ANY interchange. Thus innovation is directed toward revenue (a logical imperative), and conversely merchant avoidance is based upon cost/value (hence no adoption of card POS tokens).

The EU’s ELMI model is perhaps the best developed regulatory standard. Perhaps the US pursues something similar which would serve as a federally chartered MSB. Or provide for existing MSBs to operate (and assume risk) on a settlement network (like Fed wire).  This is my core recommendation, rather than taking a 5 year approach, the Fed should create an open settlement service, in which private utilities (ACH, Visa, …) must compete with. Australia (EFTPOS) and Canada (Interac) have both successfully consolidated debit infrastructure as a result of regulatory mandates (and these remain bank owned networks). Today Fedwire competes with TCH in settling payments, but garners much less than 1% of settment (see FedWire Volumes).

The Fed should consider consumer requirements and preferences, after all it is the consumer’s money. Similar to the MCI telecom case, regulators should consider the minimum consumer servicing requirements. If a consumer wants to pay through an intermediary (like PayPal, Amazon, Google, MCX, … ), or have money stored with an intermediary, or want to remain anonymous to the merchant in a transaction, they should be able to do so. As the Visa model evolves, Consumers should be able to INITIATE the payment request with the Bank (as opposed to the Visa/MA model of merchant requesting payment based upon consumer credentials).

Today, ODFIs are responsible for all risk (in ACH and Card Present). The Regulatory burden they face is substantial (Fed, OCC, CPFB, …etc.).  There are very big plans by the banks to gain tighter control over the payment network (see Tokens and Consumer Authentication).  Fundamentally, if we want change, we must improve transparency and allow risk to be assumed by non banks (and consumers).  Consumers should have the choice to take the slow railroad (with guaranteed delivery) or an instant transfer that cannot be reversed.

The FED should be very mindful that their direction does not just impact Innovation at the top end of the consumer pyramid: over 40% of US consumers are unprofitable to US Banks (see Prepaid – Future of Banking?). The Amex/WMT Bluebird product is proving to be an attractive alternative “banking lite” product with ability to direct deposit. The story of MPESA in Kenya may be useful here, as a non-bank was granted an exception which enabled the service to grow from 0 to 10% of the GDP in 3 yrs. Regulators and the Central bank do NOT look favorably on this development, as 10% of the GDP flows out of M1 into a single non-interest bearing settlement account which cannot be leveraged by banks to offset loans (ie liquidity ratio). But consumers love the service…

Key Topics which I believe need to be addressed:

#1 Bank Ownership and Control of the Payment Rails

  • Cost Transparency/Reporting
  • Speed Transparency/Reporting
  • Transparency of Rule Making and Voting in Infrastructure
  • Non Bank Ability to Connect
  • Non Bank Ability to Take Risk
  • Non Bank Participation in Settlement (ex Federally chartered MSB, or non-bank access to FedWire)
  • Consumer Authentication Standards, and Ability for non-banks to assume role (see KYC)
  • Common Reporting/Alert Interface in Transaction Origination and Settlement

#2 Issuance and Value Storage (from How to Deregulate Payments like Telecom)

We need to look no further than BitCoin to see the need for new regulations surrounding issuance. Transfer of funds between entities is covered above, and my view is that non-bank participants should be licensed and agree to abide by current money transfer  regs (ie. Fincen/AML, ..). Issuance of “credentials” and storage of funds is another matter. Long term storage of funds is a banking function, and should be regulated, settlement funds face state escheatment issues (but largely unregulated unless interest is paid), while storage of “Value” is completely unregulated (ie Coupons – a form of legal tender, Pre paid offers, bitcoins)?

From above, if we allow non-banks to participate in real time funds transfer, third parties (ie Sofort) would act as agents (on behalf of consumer, merchant or bank) to direct the funds and assume risk on behalf of consumer. If a good/service is purchased immediately (commerce) then there is no regulation, however if the value is “held” for future use it is generally regulated (hence MSB, eGold, bitcoin issues). Thus the rules under which third party senders operate (as agents), are different from the entities at the end of the transactions (banks, merchants, consumers). See ACH Origination Risk.

As in the MPESA example above, there is an obvious CONSUMER need for issuance to more closely resemble cash in its ease of exchange, verification, anonymity and storage.

Our current need is for simplified laws surrounding account under a given value amount (say $2000). Providers of service should be lightly regulated through self reporting, “transparency”, and the need to keep settlement funds with the Fed. In this proposed model, a bitcoin exchange must ensure that no single individual has processed more than the threshold in a given time period. Hence the need for KYC of exchange participants (when converting to cash).

Summary – new HUB vs evolving existing networks

The current ACH system will never go away (related blog). There were $33.91 TRILLION moved over the network in 2011, compared to total debit and credit volume of around $4.5 Trillion. What path should regulators take?

#1 Improve ACH (primarily speed and fraud management). The highest priority will be around third party senders (TPS), the lowest priority will be regular customer directed debits and payments to billers.

Third party senders (TPS) are a subclass of Third Party Service Providers (TPSP) which originate ACH transactions based on a direct consumer relationship.  Alternatively TPSP are also known as “processors” whose customers are banks (primarily) and have no direct consumer relationship. Banks are not happy with the “free riders” on their network (see  blog). Most bankers view companies like PayPal and Xoom as riding on their rails for free. One of their biggest issues is that they do not have visibility into the actual beneficiary as the settlement account hides where the payment is going to. This impacts their ability to perform risk management and authorization. Take these issues together with the increased regulatory focus on AML and we have a fertile environment for change (HSBC’s See Deferred Prosecution Agreement, and business overview of HSBC’s issues from Reuters). Note that AML concerns are much more relevant to International ACH Transactions (IAT). This blog is not focused on IAT.Token

Banks must therefore architect a solution to evolve ACH while the ship is moving. This is a much better approach than that taken by the UK of mandating faster payments… (one bank was losing 30M GBP a WEEK from fraud when launched). The consensus approach seems to be one surrounding tokens and directory (my blog from last year Directory Battle Phase 1).

#2 Build a new competing network (around Fedwire) which would allow for non-banks to assume risk

 

Sorry for abrupt end.. I’m sounding repetitive.. .so I’m stopping

Controlling Wallets – Battle of the Cloud Part 3

The networks are now in the midst of defining new rules to ensure they can “influence” wallets. Banks have legitimate concerns surrounding ability support consumers and adjust their risk models. But the real business drivers here control and customer data.

#1 CUSTOMER DATA

14 MAR 2013

Short blog today.. patent law changes tomorrow and need to get something filed.

Efforts to “control” have unintended consequences.. like holding onto your Jello by squeezing it..

The networks are now in the midst of defining new rules to ensure they can “control” wallets. I wrote about this a few months ago in Don’t Wrap Me – October 2012 and Battle of the Cloud – Part 2. The threat to banks from “plastic aggregation” at POS from solutions like Amex/Serve, PayPal/Discover, Square/Visa, MCX, Google is real. Make no mistake, Banks have legitimate concerns surrounding ability support consumers and adjust their risk models. But the real business driver here is to “influence” mobile payment solutions that do not align to their business objectives. Key areas for bank concerns:

  • #1 CUSTOMER DATA
  • Top of wallet card (how does card become default payment instrument)
  • Credit card ability to deliver other services (like offers, alerts, …)
  • Ability for issuer to strike unique pricing agreements w/ key merchants
  • Brand
  •  …etc

Each network is in midst of creating rules which will ensure it has control and can see merchant/consumer transaction.

The buzz this week is surrounding Mastercard’s new Staged Digital Wallet Operator Annual Network Access Fee (MA detail reference not avail).

  • What is it? Well since I don’t have the Dec 20 rule in front of me I have to go off my notes.
  • Applies to wallets that facilitate POS commerce between merchants and consumer (not ecommerce)
  • Who is responsible? It is largely a new processor responsibility. They are responsible for identifying wallet transactions
  • New transactions sets? Yes. Currently aggregators can be the merchant of record, but new rules require the MID of purchase and a new WID (WALLET ID) to be transmitted.
  • New fees? Yep.. looks like around 35bps on LAST YEARS volume
  • Timing? Goes live June 2013. Processor technology complete by April 2013

This is a brilliant move by Mastercard… but there may be some unintended consequences as issuers will have control over how it is applied.  MA’s objective?  “influence”  PayPal/Discover, Amex/Serve and Square/Visa, MCX…  NOTE eCommerce is NOT the focus (Apple/Amazon). However MA seems to be tying themselves in knots trying to differentiate a ecommerce aggregator (Amazon) from plastic aggregator (ex. PayPal/Discover).

These changes are already having “material” consequences. In eBay’s 2013 10k Page 19

MasterCard has recently announced a new Staged Digital Wallet Operator Annual Network Access Fee which would apply to many of PayPal’s transactions if the buyer uses a MasterCard to fund their payment, and will be collected starting in June 2013. PayPal’s payment card processors have the right to pass any increases in interchange fees and assessments on to PayPal as well as increase their own fees for processing. Changes in interchange fees and assessments could increase PayPal’s operating costs and reduce its profit margins.

Also see the long discussion by Amex’s Dan Shulman

http://www.reportlinker-news.com/n061421027/American-Express-Company-SemiAnnual-Financial-Community-Meeting-Final.html

UNIDENTIFIED AUDIENCE MEMBER: Thanks. I have a question for  Dan Schulman.  MasterCard recently revealed that they’re introducing this digital wallet that I’ll read it’s called the staged digital wallet operator annual network access fee. It’s one of his famous acronyms.  I was going to ask has Amex contemplated a digital wallet fee as well? And generally do you think the optics of digital support merchant discount rates, are they going higher or lower in a card not present world?

DAN SCHULMAN : So I think you’re seeing a lot of different players whether it be traditional or non-traditional start to think through the digital wallet strategy. And we’ve said this and it’s still absolutely true, this is the very early innings of this play out with digital wallets right now. We’re beginning to get some very nice traction in the back half of the year. It’s kind of on our digital platform right now.  We have looked very hard at the different fee structures that are out there. We’ve looked at the embedded infrastructure that we have. As Ken mentioned we have a kind of fixed infrastructure that we can leverage. We have a lot of assets that we can leverage that are very different than other players out there right now.

So I wouldn’t expect that fee structures are necessarily going to mimic each other because each of us come to the market with different assets and different profiles. If you look at some of the kind of newer players that have come into reloadable prepaid, they’ve got very different infrastructures and therefore have to have very different fee structures if you look at a  NetSpend  or a  Green Dot  they charge on their, kind of what they are beginning to try and call wallets, they’re charging monthly fees that can be $4.95

A new WID  has multiple uses. It enables MA issuers to enhance their risk models and “decline” both individual transactions from a wallet, as well as decline wallet providers that are not “certified”.  Amex already has similar rules in place, their summary view seems to be that Serve can wrap everyone else’s card… but no one can wrap theirs (for physical commerce).

Banks love the original NFC model where cards had to be “provisioned” into a wallet. Banks were in complete control of which wallets to “authorize” and completely hid the card number (purchase data) from the wallet provider.  This perfect world broke down quickly as the first NFC wallets had space for only one card emulation application (see Forces against NFC) so there were 2 options: allow only one card type, or enable a single card to represent multiple cards (See Blog). Now that NFC in payment is dead just about everywhere (except Asia), banks are looking to enable this “provisioning” control within the network level. MA is just the first visible instance, as I outlined in NEW ACH SYSTEM the Banks are also doing the equivalent to ACH debit through tokens probably 18mo- 2 yrs away.

And we wonder why mobile payments aren’t taking off.

Retailers look at this change and see complete imbalance… Networks which will change rules in weeks to satisfy banks. V/MA you may want to consider a new transaction set which would force issuers to define price of a specific card for that specific merchant (interchange), and acquirers their fees (MDR)… then share that information with other retailers.  Then allow retailers to decline based on price… (as opposed to accept all cards). That would certainly level things out…

I do think there are many ways to get around this.. but  I will not be putting them in this blog ($$).  All surround who owns the customer… and 5 “LAWS OF Commerce”:

  • Commerce will always find the path of least resistance
  • Consumers are NOT owned, but rather migrate where there is value
  • Value can be delivered by price, product and also through great consumer experience
  • Most Retailers face life selling commodity goods at a higher price… experience is all they have left
  • Banks have never held a sustained role in controlling commerce, they influence and support it.

In all of this bank control.. where is there value? What does a JPM Sapphire Card actually do that is differently than a platinum Amex or a sub-prime Capital One? Brand, points, loyalty… these are qualitative attributes.. but what if there were REAL value differences? Where is the customer relationship. Note that Retail Banking is going through many FUNDAMENTAL changes (see blog)

Tim Geithner visited a friend of mine prior to his departure. My input question to him was what if core “Bank accounts” morphed from Net Interest Margin (NIM) profitability to “Trust Accounts” where the key to profitability was consumer data? (See blog Payment Enabled CRM)

With respect to squeezing Jello… as the banks angle for control EVERYONE else is looking toward least cost routing (see Blog). The payments system is not a set of 5 pipes.. Just as the internet backbone is not run on a single piece of fiber. Changing all of the rules for everyone and stopping the leaks is hard work…

payments pyramidI would love to set up a Wiki site where we could list the features differences and customers of all of these digital wallets.

.. back to my patent app .. oh and corporate taxes due tomorrow too. Yuck.

Payment Tokenization

Banks don’t really want consumers to choose… not really… they will make their favored option seamless and ensure friction with everything else. This is normal business behavior, but payments are a networked business. Banks SHOULD be neutral here.. they DO NOT direct commerce but support it.

From blog yesterday I had several friends ring me. Turns out the card networks and individual banks are SEPARATELY pushing Token ideaS..  unfortunately none of the token schemes has individual adoption, no less interoperability.

Per my blog yesterday, ACH debit tokens can work, particularly if the consumer doesn’t have to enter them. Also in ACH, banks are in a position to influence acceptance.  Consumers could even go to the online bank to permission the payment instrument in the first place. This is the model of V.me and Google wallet (w/ the new Saveto API). In this model the consumer never enters anything.. the BANK enters the customer information in the wallet. Of course banks DO NOT want consumers to use ACH.. there is no revenue here.

Therefore Banks don’t really want consumers to choose… not really… they will make their favored option seamless and ensure friction with everything else.  This is normal business behavior, but payments are a networked business which supports Commerce. Banks SHOULD be neutral here.. they DO NOT direct commerce but support it. Their partnering approach is thus completely broken…

Thus the conundrum. The network where banks have the most influence is ACH, yet they don’t want to encourage ACH use as there is no revenue. We have a world where consumers can enter information directly, or ask their bank to enter it for them (V.me and Google).

One bank even seems to be creating a scheme that blends both ACH tokens AND Credit card tokens… in the hopes of being the “master directory” of payment information in a consumer’s wallet. Their dependency: consumer, merchant and wallet participation (ie. when pigs fly).

Why would any merchant want to give up card information and exchange it for tokens? Well there could be some incentive with reduced CNP rates.. and fraud liability shift… but isn’t that 16 digit card number already a token? Any approach must start out by being invisible to consumers (like V.me.. yes I am saying something nice about Visa).

I was talking to the KC Fed a few months ago.. brainstorming a little.. like what if you opened up Fed Wire to non-banks (ie regulated MSBs). That would really throw a wrench in all these future token plans… well I guess there would be one little problem… fraud.. but if an entity could crack the authentication/authorization nut this would be a great approach.

vme enrollment

“New” ACH System in US

The current ACH system will never go away (related blog). There were $33.91 TRILLION moved over the network in 2011, compared to total debit and credit volume of around $4.5 Trillion. However, there are several “improvements” to ACH where all could benefit, primarily speed and fraud management.

19 Feb 2013

(sorry for typos in advance)

Thought I would add a little meat to my 2013 prediction on a new token based payment scheme in the US. 60% of the thoughts below are contrived… as participants and pilot results are not in.. and things are still evolving.

Prior to describing a “new” ACH system, it may be useful to understand what banks are looking to achieve.

  • Stop the dissemination  and storage of DDA RTN and Account Numbers
  • Control the bank clearing network. Particularly third party senders and stopping the next paypal
  • Improve clearing speed (new rules, new capabilities to manage risk)
  • New pricing scheme somewhere between debit ($0.21) and credit cards
  • AML controls (per yesterday’s blog on HSBC)
  • Taking Visa and MA out of the debit game (yes this is a major story)
  • Maintain risk models (see both sides of transaction)
  • Control Retailer’s efforts to form a new payment networkTPS Definition

Overview

The current ACH system will never go away (related blog). There were $33.91 TRILLION moved over the network in 2011, compared to total debit and credit volume of around $4.5 Trillion.  However, there are several “improvements” to ACH where all could benefit, primarily speed and fraud management. Thus I believe there will be a carrot and stick approach to creating the right incentives for ACH users to move. The highest priority will be around third party senders (TPS), the lowest priority will be regular customer directed debits and payments to billers.

Third party senders (TPS) are a subclass of Third Party Service Providers (TPSP) which originate ACH transactions based on a direct consumer relationship.  Alternatively TPSP are also known as “processors” whose customers are banks (primarily) and have no direct consumer relationship. Banks are not happy with the “free riders” on their network (see yesterday’s blog). Most bankers view companies like PayPal and Xoom as riding on their rails for free. One of their biggest issues is that they do not have visibility into the actual beneficiary as the settlement account hides where the payment is going to. This impacts their ability to perform risk management and authorization. Take these issues together with the increased regulatory focus on AML and we have a fertile environment for change (HSBC’s See Deferred Prosecution Agreement, and business overview of HSBC’s issues from Reuters). Note that AML concerns are much more relevant to International ACH Transactions (IAT). This blog is not focused on IAT.Token

Banks must therefore architect a solution to evolve ACH while the ship is moving. This is a much better approach than that taken by the UK of mandating faster payments… (one bank was losing 30M GBP a WEEK from fraud when launched). The consensus approach seems to be one surrounding tokens and directory (my blog from last year Directory Battle Phase 1).

Scheme (updated 2/20)

  • Token will replace DDA RTN/AN. Starting with ACH Debit, Third Party Senders will be required to use token for access to top 5 banks. Consumers will not know their “token” as it is unique to the requester.
  • Third party sender (TPS/TPPA) must request token for originating consumer account from consumers bank (more on business incentives below). This establishes a “directory” role for the consumer’s bank and positions them to “approve” ACH Debits, where today the responsibility is only on the ODFI.
  • The bank owning the consumer account will be the owner of the token. Individual banks may choose to issue tokens, tokens will be synchronized with a central director, banks not wishing to issue their own tokens may depend on the central directory for issuance.
  • Once a token is issued, a third party sender will use the token to debit consumer account just as the account number is today. However tokens may be unique to each TPS/TPPA
  • Individual banks may clear payments by using their own local directory, or leveraging the central ACH service. There are no forced routing rules (learning from VisaNet).  Banks also agree to collaborate on fraud and risk (keep information fresh).
  • A token will be unique and represent a combination of both sender and beneficiary information. Focus is initially on ACH Debit. Unclear if multiple tokens will be required in MSB scenario. Banks want visibility beyond settlement account. Multiple ways to achieve.
  • Members of scheme agree not to store consumer DDA/account information after token is received (think PCI for ACH).
  • Token issuance (by the originating bank) will take into account, KYC, fraud and other factors
  • Tokens may be revoked and tokens may correlate to risk/fraud information
  • TPS may be required to include beneficiary information for ACH Debit (my guess here). This may take the form of a unique token for every originator-beneficiary combination.
  • Authorization and intra bank settlement begins to look exactly like debit card/ATM. Only piece missing are agreements which would support usage outside of V/MATPS Noyes

———- Update 20 Feb—————————————-

It seems the Directory service has credit and debit cards in scope… I haven’t fully processed this one. Why would Visa and MA want banks wrapping the card number? Talk about a scheme to cut them out of the loop. Once proxy numbers are issued they could just dump other networks immediately..  Merchant acceptance becomes the big question mark if this is the case. My guess is that banks will focus on mobile, and eCommerce.. defeating V.me, I’m sure CYBS, AMZN and eBay will all jump at the chance to help banks with their tokens

Token provider rumored to be start up Venmo

—————————————————————-

Carrots/Sticks

In the ACH world, the big banks rule.. and make the rules. My guess is that the top 5 banks will inform (and subsequently enforce) a rule on all TPS ACH debits requiring use of Tokens to access consumer accounts. Given that the big 5 have over 50% of the accounts… if they act in concert it will certainly impact the network. The focus of their action is on Third Party Senders, with mobile payments and remittance services as primary examples.

  • NACHA may issue new rules which will change existing ACH. My guess is that we will have a new transaction type (associated with TPS, and token). Note that new NACHA rules become law uniform commercial code.
  • NACHA has already begun tightening requirements on TPS/ODFI relationships (Section II, Chapter II (ODFIs), subsection B-3)
  • Banks which serve as correspondent aggregators of ACH (for MSBs/TPS) may be pressured to make immediate changes (beneficiary data, tokens). These payment aggregation banks (which frequently serve as ODFI) will likely not be part of the system design
  • To “enforce” the rule changes, the large banks will set a date where they will not accept transactions that do not conform
  • There will likely be “options” for fraud checking, and accelerated clearing cycle (Carrot?)
  • Processing Token transactions will have a different baseline fee

Implications

  • If your clearing bank is not one of the top 5, they may not even know this is going on
  • PayPal, MCX, Google Wallet, Target RedCard are all likely dependent on some form of ACH. They will likely have incremental costs associated with ACH origination as a third party sender. My guess is that it will be at least $0.21.
  • The big 5 banks will be best positioned to help any start up navigate this changing environment.
  •  It may be better for start ups to focus on obtaining consumer debit card information vs. DDA
  • Small banks that specialize as ODFIs will be squeezed
  • The cost of ACH is going up..

ACH Origination Risk

US banks are getting out of the business of supporting MSBs as the regulatory burdens increase. The most recent (and significant) are CFPB’s final section 1073 rules.

I’ve been thinking about several active projects going on in Start ups, bank networks as well as the Xoom IPO. Who owns origination risk for ACH?

Here is a good Story… back in 2002 banks did not allow for online fund transfer. If you wanted to move money from one bank to another you had to write a check and deposit it at the ATM.. and wait 5-7 days. Online brokerage services (etrade, schwabb, … ) did provide the service. BAC broke the mold in 2003, and my team at Wachovia followed. Both Wachovia and BAC used Cashedge (now part of FISV and still good friends of mine).

The general transaction flow (after registration and account ownership verification)

– Debit sender’s account, credit settlement account (good funds)

– Credit beneficiary account, debit settlement account (good funds)

Rather simple stuff.. but there was one big problem. Cashedge was using a very small California bank Calnet for settlement. Can you imagine.. everyone of their big banking customers (including BAC) were putting settlement funds into this tiny little bank which was originating transactions DAILY at a value close to its asset size. We caught this in project due diligence and subsequently set up a separate WACHOVIA settlement account in our business banking facilities. In this model Cashedge became a third party sender for us operating as ODFI.

This Fed whitepaper outlines a few of the risks in ACH origination. Today the large banks have taken a regulatory view that they own the risk on EVERYTHING  that debits their customer’s accounts. Furthermore they are responsible for every originating transaction (even for MSBs that maintain an aggregate settlement account), particularly KYC.

OCC Bulletin 2006-39 clearly addressed the need for ODFIs to know details about all  participants in third party relationships by indicating that financial institutions “should  know, at a minimum, for which Originators they are initiating entries into the ACH Network

This KYC issue is one of the things the lead to the death of HSBC retail in the US (See Deferred Prosecution Agreement, and business overview of issues from Reuters). Demonstrating there are big risks for third party senders that don’t know their business clients. This NACHA whitepaper provides results from a third party sender survey with NACHA banks.

US banks are getting out of the business of supporting MSBs as the regulatory burdens increase. The most recent (and significant) are CFPB’s final section 1073 rules.

Section 1073 of the Dodd-Frank Act amended the Electronic Fund Transfer Act to require remittance transfer providers to provide disclosures to senders of remittance transfers  pursuant to rules issued by the CFPB. Specifically, remittance transfer providers must give  senders a written pre-payment disclosure of specific information applicable to the sender’s remittance transfer. A remittance transfer provider must provide a written receipt that includes both the information on the pre-payment disclosure and additional specified information.

There are a number of “specialist” banks operating in this environment. But a key takeaway for investors is that the costs to “ride the rails” of ACH are increasing. Top 5 banks are taking the position that every bank must KYC the originating customer. Banks are not keen on supporting start ups on their infrastructure, bearing all the risk and cost of running the rails.. while others reap the benefit. This was my point behind Xoom’s $800M market cap.. a company completely built on bank infrastructure.

Payfone.. Verizon’s new mCommerce phone number based credential storage and authentication service

So why do I call this service “mCommerce phone number based credential storage and authentication service”? Verizon already has one wallet (ISIS).. they don’t want to confuse the market…

MoPoNuBaCreSAS (explained at end of post)

update Aug 2013

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General architecture below is correct. Think the first deployed “use case” will be around mCommerce. An “autofill” function similar to V.me and Google Chrome. MNOs are in a much better place to deliver this as they have information on EVERY handset.. and they can AUTHENTICATE with handset information. This is my FAVORITE MNO led payment effort in the US. Online merchants should adopt this without pause.. think you will see immediate conversion impact. See overview here http://payfone.com/1-touch-checkout/

payfone

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5 August 2011

Previous Post

I ran into a Payfone exec last month.. while stuck together in an elevator…“hey you look familiar”.. “I’m Tom… “ “You’re the guy writing bad stuff about us”… “I’m never afraid of being told I’m wrong.. tell me what is wrong”…   After spending a little time with Payfone, I’ve changed my view.. If US users can be convinced to pay with their phone numbers, and merchants can be convinced to implement the Payfone mobile payment API.. this may be a very good way to go.

What did I get wrong in previous post?

  • It is not only about P2P (at least in US).. but about mCommerce. Don’t know if I got it wrong, or whether their strategy has evolved… but today their focus is on mCommerce leveraging phone number for payment.
  • Buying physical goods with their phone number.. hey in the UK payforit is big… particularly for small purchase. VZ probably wants to have this happen because they see a very rough road ahead for ISIS.. not only will it take consumers buying handset.. it will take 6 parties to align on the value prop.. AND execute.
  • Substantial advantage in risk/fraud when carrier is involved in validation of credentials. Remember, my previous post estimated that MNO KYC could be a $5B market opportunity. Will Payfone take out other SMS verification solutions like Authentify?

My picture is based upon general market G2 (.. note I did not say “intelligence” as it may infer I have some).

What did I get right? The merchant integration challenge … I don’t see how AMEX, Payfone or VZ will be able to offer a compelling merchant value proposition. Amex is not exactly a processor of choice… Ticket sales seems like a sweet spot but hardgoods?  Re: Digital Goods.. My sources tell me that the carriers are currently doing about $600M a year in old fashion digital goods (think ringtones). Apple is doing about $1.6B in App Store, and $4.8B in other Digital Goods (previous post). Given that neither legacy digital goods (ring tones) nor App Stores need this functionality what are the physical goods use cases? Best Buy? Gap? Payforit found a great sweet spot in subscriptions and paid content (read the newspaper, video), ticketing,   …. Similar services in Japan also extend into vending.

So why do I call this service “mCommerce phone number based credential storage and authentication service“? Verizon already has one wallet (ISIS).. they don’t want to confuse the market… (great.. really great attempt here.. we would never call storing payment instruments and sending them to a merchant a “wallet”..  )

Oh.. BTW.. Citi and Verizon are both working on something substantial.. I will have to think of a new acronym for it.. how do I innovate a new word for “Offers”? Digital discount delivered by an MNO with redemption verified by a large multi-national bank? …. question remains who will actually create campaigns.. so need to put those words in there too somewhere. Suggestions appreciated.

US Senate tinkers w/ card rules and rates

The press seems to be focusing attention on the TBD rate setting and “swipe fees”, from my perspective they bigger long term impact to banks and the networks will be elimination of restrictions associated discounts on competing forms of payment. Specifically Mastercard rule 5.9.1 and Visa

http://on.wsj.com/coPzIH

US Senate Amendment Text

14 May 2010

The press seems to be focusing attention on the TBD rate setting and “swipe fees”, from my perspective the bigger long term impact to banks and networks will be elimination of restrictions associated with discounts (and steering) on competing forms of payment.

Amendment Text

“(b) Limitation on Anti-competitive Payment Card Network Restrictions.–

“(1) NO RESTRICTIONS ON OFFERING DISCOUNTS FOR USE OF A COMPETING PAYMENT CARD NETWORK.–A payment card network shall not, directly or through any agent, processor, or licensed member of the network, by contract, requirement, condition, penalty, or otherwise, inhibit the ability of any person to provide a discount or in-kind incentive for payment through the use of a card or device of another payment card network.

“(2) NO RESTRICTIONS ON OFFERING DISCOUNTS FOR USE OF A FORM OF PAYMENT.–A payment card network shall not, directly or through any agent, processor, or licensed member of the network, by contract, requirement, condition, penalty, or otherwise, inhibit the ability of any person to provide a discount or in-kind incentive for payment by the use of cash, check, debit card, or credit card.

In June 2003, Visa and Mastercard signed the settlement agreement which provided for steering.

D. Merchants shall also have the right to encourage or steer customers from Visa and MasterCard debit transactions to other forms of payment.

This ability to steer has been somewhat ambiguous, outside of cash. For Example, the Mastercard rules show

5.9.1 Discrimination
A Merchant must not engage in any acceptance practice that discriminates against or discourages the use of a Card in favor of any other acceptance brand.

5.9.2 Charges to Cardholders
A Merchant must not directly or indirectly require any Cardholder to pay a surcharge or any part of any Merchant discount or any contemporaneous finance charge in connection with a Transaction. A Merchant may provide a discount to its customers for cash payments.

and Visa Rules

5.2.D Discounts at Point of Sale
5.2.D.1 Advertised Price
Any purchase price advertised or otherwise disclosed by the Merchant must be the price associated with the use of a Visa Card or Visa Electron Card.
5.2.D.2 Discounts
5.2.D.2.a A Merchant may offer a discount as an inducement for a Cardholder to use a means of payment that the Merchant prefers, provided that the discount is:
• Clearly disclosed as a discount from the standard price and
• Non-discriminatory as between a Cardholder who pays with a Visa Card and a cardholder who pays with a “comparable card”

Will update this blog later, but the US Senate’s amendment will have substantial impact on merchant payment strategy. I see a strong future for new cards issued by  merchants that embed strong loyalty program.. outside of the Visa/MC network (?ACH?.. PayPal…) with a substantial rewards program to drive adoption. Perhaps ACH POP will take on new life..

Card networks and issuers should get active in the merchant funded rewards space.. before the merchants own it

http://www.paymentssource.com/news/merchant-funded-rewards-spark-card-issuers-interest-2637491-1.html