Brexit's Potential Impact on the UK Payments Industry

Like many around the world we have followed the trials and tribulations of Brexit with great interest.  It is beyond the scope of this blog to enter into the fraught territory of predicting the United Kingdom’s future relationship with Europe.  However, we have been following Brexit’s potential impact on payments regulations in the United Kingdom given the potential impact to UK merchants and Fintechs.  Below we offer a brief summary of how the application of the key EU payments regulations could change post Brexit. Given the uncertain state of Brexit and the complexity and fluid nature of this topic, this is meant solely to illustrate the potential issues post Brexit and is not intended to provide definitive legal conclusions on these questions.  Our London office would be happy to answer any questions as this issue evolves.

In short, the bulk of the financial regulation applicable to payments in the UK derives from EU legislation. As a result, the nature of any future Brexit-related agreement between the UK and EU will materially influence the immediate future of payments in the United Kingdom. Against this backdrop, the following key regulations might be impacted:

• The revised Payment Services directive (PSD2)
• Interchange Fee Regulation
• Passporting
• The Single Euro Payments Area (SEPA)
• The UK access to euro payment systems.

PSD2

The revised Payment Services Directive is the main piece of legislation governing payment services in the EU and provides the legal basis for an EU single market for payments. PSD2 covers the following types of payment system providers (PSPs): payment institutions, including registered institutions; credit institutions; e-money institutions; post offices; and central banks, other than when acting in their capacity as a monetary authority or carrying out other functions of a public nature.

Notwithstanding the outcome of the Brexit negotiations, the UK’s departure is likely to lead to a limitation in the scope of application of PSD2 for UK-related payments. Transactions that would currently fall within the category of intra-EEA payments in a currency of an EEA Member State may, post Brexit, be treated as “one-leg-out” payments by the payment system providers located in the EU.

It should be noted that the guidelines for authorisation under PSD2, published by the European Banking Authority (EBA),[i] require detailed information on the profile of the applicant. Even though, in the regulations implementing the Directive in the UK, the FCA requires existing payment system providers to obtain re-authorisation under the EBA guidelines, other EU Member State regulators may take a different approach and impose separate requirements in their assessment of an applicant’s profile.

Interchange Fee Regulation

The EU’s Regulation of interchange fees for card-based payment transactions (EU IFR) provides a harmonised regime for the fees charged for card-based payment transactions carried out within the EEA. The EU IFR imposes the following caps on the interchange fees that can be set: (i) 0.2% of the total value of the transaction for consumer debit cards (including prepaid cards); and (ii) 0.3% of the total value of the transaction for consumer credit cards.[ii] It should be highlighted that, until very recently, these caps only applied to transactions where both the merchant’s acquirer and the card issuer were located within the EEA. On 29 April 2019, the Commission accepted binding Commitments from Visa and Mastercard also with respect to inter-regional interchange fees (i.e. interchange fees applied to payments made in the EEA with consumer credit and debit cards issued outside the EEA).[iii] The caps do not apply for payment transactions carried out outside the EEA with EEA-issued cards (e.g. post-Brexit card payments made in the UK with EEA-issued cards).

Against this backdrop, the UK government has published a draft statutory instrument[iv] which introduced amendments to relevant EU legislation. The government explained that these changes will take effect only after the end of any transition period agreed to by the EU and UK. Under the domestic IF Regulation, card scheme operators will be able to set higher interchange fees for cross-border transactions, and thus, UK merchants could be exposed to such increases. EEA card issuers may therefore receive more interchange fees from transactions at UK merchants. By contrast, following the recent Commitments decision, UK issuers will be unable to receive higher interchange fees from transactions involving EEA merchants. Finally, the domestic IF Regulation clarifies that, where both the issuer and acquirer are located in the UK, the caps on interchange fees will be set at the same levels as those for intra-EEA payment transactions under the EU IFR.[v]

On a separate note, the authority of the European Commission to set regulatory technical standards for the separation of card schemes and processing entities will be transferred, at domestic levels, to the UK’s Payment Systems Regulator.

Passporting

The EEA financial services passporting regime enables firms authorised by the regulatory authority of one Member State to provide services to customers everywhere within the EEA, without having to obtain any additional local/national authorisation. Passporting rights have undoubtedly bolstered London’s leading position as a global financial centre, by providing pan-European access for firms coming to the UK from Europe or abroad. The passporting system relies upon domestically-implemented EU legislation – in the UK, the Payment Services Regulations (PSRs).

As part of the Draft Brexit Regulation,[vi] the UK Parliament agreed to the creation of a Temporary Permissions Regime (TPR) akin to that contained within EEA Passport Rights. The TPR will enable firms that currently passport into the UK market to continue operating in this country, even if the passporting regime falls away abruptly when the UK leaves the EU. The TPR imposes additional obligations on PSPs and requires them to safeguard UK customer funds under national legislation. At present, customer funds must be placed in a segregated bank account with an EU credit institution. The Draft Brexit Regulation now extends the scope of safeguarding provisions by permitting safeguarding arrangements to be made with any credit institution or insurer in the world.

Nonetheless, the EU has not clarified how safeguarding will work in cases where a UK PSP has a European subsidiary that has placed its funds in a segregated bank account with a UK bank. As this bank would no longer be considered an EU institution, the most likely post-Brexit scenario dictates that the European subsidiary of the UK payment system provider will have to find a credit institution within the EEA to safeguard its money.

The Draft Payments and Electronic Money Regulation further acknowledges that UK subsidiaries might need some extra time to adapt to the new regulatory standards and become fully operational post authorisation. In this regard, the EU Exit Regulations provide for a three-year period from exit day during which the EEA entities will continue to provide services freely using the TPR.

SEPA

The Single Euro Payments Area harmonises the way cashless euro payments are made across Europe. It allows European consumers, businesses and public administrations to make and receive credit transfers, direct debit payments and card payments under the same basic conditions. In this respect, cross-border electronic payments between the participant countries[vii] are treated in the same way as domestic transactions. The UK is currently a member of the SEPA scheme, but that will cease to be the case once it formally leaves the EU. However, the UK government is keen to retain its membership of the SEPA system, post Brexit.[viii]

On March 7, 2019, ahead of what was then expected to be the departure date of the UK from the EU (March 29, 2019), the European Payments Council[ix] published a decision paper on Brexit and UK PSPs’ participation in SEPA schemes. According to the decision paper,[x] there are over 150 UK payment system providers currently participating in the various SEPA Credit and Debit schemes. The paper analysed several scenarios regarding Brexit and the UK Payment System Providers’ participation in the SEPA schemes. It also announced the Council’s decision with respect to the participation of the UK payment system providers in the SEPA scheme, in the event of a no-deal Brexit.

According to the European Payments Council, if the UK leaves the EU with a “soft-Brexit” agreement, the UK PSPs’ participation in the SEPA schemes is not likely to be materially affected. If the UK leaves the EU but remains in the EEA for instance, and the UK payments legislation is still aligned with the EU legal framework, UK payment system providers will be allowed to continue their participation in the SEPA schemes. The outcome would be the same in the event the UK leaves both the EU and the EEA but signs a free trade agreement with the EU which results in “functional equivalence” of the EU legal framework.

Importantly, the board of the European Payments Council announced its decision to approve the application submitted by UK Finance, on behalf of the UK Payment system providers, for the continued participation of UK PSPs in the SEPA schemes even in the event of a no-deal. This decision will be subject to periodical revision to ensure the continued compliance of the UK with the SEPA scheme participation criteria.

UK access to euro payment systems

Several pan-European payment systems are currently available to UK payment service providers. These include both retail euro systems like STEP2 and wholesale systems like EURO1 and TARGET2.[xi] The UK PSPs’ access to these systems post Brexit will ultimately depend on the outcome of the Brexit negotiations and any amendments to the relevant payment system’s admission criteria. The form of Brexit will most likely affect the conditions for sending and receiving euro-denominated transactions and might end up in UK users enjoying less favourable terms, higher fees or even longer settlement times.

From the perspective of market participants, the biggest impact will be caused by the inability of firms to use a non-connected UK payment system provider for euro clearing purposes in the future. This change will affect not only PSPs and broker dealers that use UK banks for euro correspondent banking services but also payment institutions and electronic money institutions, as well as non-bank financial institutions, such as investors and fund managers. Therefore, post Brexit, market players will have to seriously consider holding an account with a payment system provider in the EU.

While the uncertainty surrounding Brexit continues, payment system providers established and/or operating in the UK have no choice but to prepare for all eventualities.

[i] Available at: https://eba.europa.eu/documents/10180/1904583/Final+Guidelines+on+Authorisations+of+Payment+Institutions+%28EBA-GL-2017-09%29.pdf

[ii] Commercial cards (used for business expenses) and cash withdrawals using debit or credit cards are excluded from the caps of the EU IFR.

[iii] The Commitments decision made an at least “controversial” distinction between card payments carried out by the cardholder in a shop (“card present transactions”) and online payments (“card not present transactions”).  For card present transactions, the card schemes must reduce, within six months, the current level of inter-regional interchange fees to or below the following binding caps: (i) 0.2% of the value of the transaction for debit cards; and (ii) 0.3% of the value of the transaction for credit cards. The caps will be significantly higher for card not present transactions: (i) 1.15% of the value of the transaction for debit cards; and (ii) 1.50% of the value of the transaction for credit cards.

[iv] Available at: https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/756931/Interchange_fee_SI_draft_text.pdf

[v] That is 0.2% of the total value of the transaction for consumer debit cards and 0.3% of the total value of the transaction for consumer credit cards.

[vi] The “Draft Payments and electronic money (Amendment) (EU Exit) Regulations” is available at: https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/738501/v1._180903_e-money_payment_services.pdf

[vii] SEPA covers the whole of the EU and it applies additionally to payments in euros in Iceland, Norway, Switzerland, Liechtenstein, Monaco and San Marino.

[viii] See also the guidance on “Draft EU Exit SIs for payment services, e-money and the SEPA Regulation” published by the HM Treasury at: https://www.gov.uk/government/publications/eu-exit-sis-for-payment-services-e-money-and-the-sepa-regulation.

[ix] The European Payments Council is an international non-profit organisation which has as its main task the development of the Single Euro Payment Area.

[x] Available at: https://www.europeanpaymentscouncil.eu/sites/default/files/kb/file/2019-03/EPC065-19%20EPC%20Board%20Decision%20Paper%20on%20Brexit%20v1.0%20-%207%20March.pdf

[xi] For more information on the settlement and processing cycles, see the dedicated webpage of the European Banking Authority: https://www.ebaclearing.eu/services/step2-sct/settlement-and-processing-cycles/