On November 6, 2017, the Competition Bureau (the "Bureau") published its report on the Canadian financial services sector and FinTech. The report examined a wide range of FinTech activities and focused heavily on retail payments and retail payments systems.
The Bureau observed that, while FinTech has a real potential to penetrate the retail payments space in meaningful ways, it identified a variety of barriers to entry, some attributable to regulation, and some not.
Those barriers not attributable to regulation include:
- Canadian consumer behaviour (including a high degree of trust in existing payment providers and methods) and market maturity.
- The impact of network effects and the need for economies of scale: a critical mass of users is required for a new retail payment system or method to gain acceptance in a market.
- Lack of access to core bank services, which are essential to establish a FinTech product or service. The Bureau reports that some FinTech entrants expressed difficulty in obtaining the basic banking services required to operate. The Report went on to state
While banking services are critically important for any new business, entrants in the retail payments sector are in a unique position: they are direct competitors to some financial institutions' products and services but still rely on those institutions' services to meet the needs of their end users. As such, incumbents are in a position where they can effectively block the entry of any new competition.
The refusal of banking services can add to the sunk and ongoing costs of entry for new firms, resulting in ineffective or delayed entry.
Regulatory barriers involve a combination of regulatory uncertainty for non-banks attempting to enter the market before the Federal Government's Retail Payments Oversight Framework is complete along with limited access to the retail payments system run by Payments Canada. While the Bureau's reaction to the proposed Framework was positive, it had several recommendations for the Department of Finance to keep in mind to appropriately balance competition and regulation. Indeed, noting that a sound, secure, and efficient payments system is the backbone to a strong Canadian economy, the Bureau went on to stress that, while a strong regulatory framework is needed to ensure payments are made and received in a safe, secure and expedient way... these important regulatory constructs can sometimes have unintended consequences that slow innovation and reduce competition.
Therefore, according to the Bureau, regulation in the retail payments space should be:
- as technology neutral as possible;
- principles-based rather than driven by prescriptive rules;
- functionally, rather than institutionally-focused ; and
- proportional to the risks it aims to mitigate.
Readers familiar with the Department of Finance's proposed Oversight Framework will recognize many similarities between the Bureau's proposal and the draft Framework. (for a summary of comments, see this link....)
Unsurprisingly, the Bureau also recommends broader (i.e. non-financial-institution access) to Payments Canada's retail payments system – the Automated Clearing and Settlement System (the "ACSS"), arguing that
Broader access to the ACSS, altering the Payments Canada membership criteria and creating a regulatory framework based on the functions carried out by a PSP can help mitigate the competitive impacts noted above, and increase the level of competition and innovation in payment services to the benefit of consumers and business.
The Bureau's Recommendations
The Bureau's review of the retail payments system led it to conclude that:
The keys to encouraging competition and continued innovation in the payments services sector are access, awareness and ability to induce switching. From this conclusion came eight recommendations, which are briefly summarized below.
- Regulators should allow payment service providers and financial institutions to collaborate in pro-competitive ways, while recognizing the potential risks of such collaboration.
- Merchants should continue to be permitted to use incentives to encourage consumers to adopt alternative or lower cost payment methods. Regulators should also examine measures that target interchange fees.
- New entrants need access to banking service and it is crucial that all participants in the payments system understand their legal and regulatory responsibilities. Moreover, the framework needs to be sufficiently clear and stable to help ensure that financial institutions are not incentivized to thwart the efforts of new entrants attempting to introduce novel services. The new retail payments oversight framework and current regulatory requirements, like AML/CTF should afford FinTech entrants the opportunity to maintain bank accounts and access established payments infrastructure.
- Financial institutions should be required to provide reasoning and supporting evidence when terminating or refusing to service a business, such as an MSB. Applicants who are refused or clients who have their accounts terminated should have a suitable course of redress, such as the Ombudsman for Banking Services and Investments.
- Policymakers should consider access to ACSS on open and risk-based criteria.
- Payments Canada should consider allowing non-financial institutions to access the exchange function of payment systems such as the ACSS and in the future, the real-time rail. It should also explore the possibility of providing an application programming interface (API) or a direct technical interface or access point for eligible participants, particularly for the real-time rail.
- Regulators should assess the possibility of moving toward a real time settlement model for its core clearing and settlement system in an effort to provide broader direct access to the payment systems operated by Payments Canada for PSPs and financial institutions.
Comments were invited until November 20, 2017. The Bureau aims to publish its final report by the end of 2017.
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