Autonomous Research recently held a forum to update their customers from the investment and asset management community on recent developments and trends in payments. I was invited to speak, and shared the podium with representatives of high street and challenger
banks, Fintech start-ups and payment service providers.
The audience were considering where to place funds over the next few years, so the questions revolved around who the winners and losers in the emerging payments landscape might be. The main question was whether PSD2 and instant payments are a threat to cards.
Two clarifications to the question
I feel there are two things we need to distinguish. Firstly, PSD2 does not mandate instant payments. As long as payments initiated by third parties are executed just as quickly as those made directly by the customer, next day is fast enough. The initiative
to introduce instant payments to mainland Europe, SCTinst, is independent of PSD2.
Secondly, it is misleading to think about card payments as a single type of payments. Payments with a physical card at a point of sale are quick, efficient and, if using chip and PIN, secure. E-commerce and m-commerce transactions requiring the customer
to key in the card number, expiry date, security code, name and address are anything but convenient, and solutions such as mobile wallets have already been created to make the customer experience less painful.
A different threat to different organisations
So the answer is that PSD2 payments are certainly a potential threat to card payments in the digital world, though probably less so in bricks and mortar retailers. The size of the threat depends on the rate of customer adoption, which in turn is driven by
a number of factors.
The most obvious factor is the quality of the customer experience. It has been suggested that a new payment method must be ten times better than the existing one to drive customer adoption. One speaker disagreed, saying that he loves using contactless cards
even though they are only marginally quicker, and that consumers would use new methods simply for the cool feel-good factor. The speaker was the CEO of a start-up bank, so “he would say that wouldn’t he” - whether regular customers would see that as a compelling
reason is debatable.
The customer experience question is further complicated by the security provisions of PSD2. One of the key objectives of the legislation is to make online payments more secure by mandating “secure customer authentication” for virtually all digital payments,
including “card” payments. This will level the playing field, potentially introducing further friction into the card journey.
Of course, customers can only adopt a payment method if it is offered to them. Merchants will only offer a new payment method if a) it costs them less than existing methods and/or b) it drives a higher transaction completion rate.
A role for acquirers?
One inevitable consequence of PSD2 is that larger companies such as the GAFA group (Google, Apple, Facebook, Amazon) will set up as Payment Initiation Service Providers, allowing them to handle their own payment processing and avoid the fees they currently
pay to card acquirers. The question arose whether the acquiring role will vanish completely for PSD2 payments. My view is that an acquirer-type role will still exist. Payment Initiation Service Providers are not allowed to hold funds; but an aggregator is
needed to collect individual payments, hold funds, and settle a daily total with merchants. The aggregator can net off fees, and can retain funds as a hedge against merchant failure or default, just as card acquirers do today.
The importance of payment experience
Although merchants are very cost-sensitive, the transaction completion rate is also vitally important. Abandoned shopping carts are a huge problem for digital merchants, and the cause is often traced to a poor payment experience. Adding a clunky customer
authentication step is the last thing they want, so are unlikely to offer PSD2 payments unless the authentication step can be made totally seamless, or eliminated. Such a thing is possible - think of Apple Pay for an exam of a virtually frictionless secure
authentication step using fingerprint biometrics. The problem is that the approach to Secure Customer Authentication is controlled by the customer’s bank, so when a merchant signs up with a given Payment Initiation Service Provider, the end-to-end customer
journey will not be consistent, and the transaction completion rate will vary according to the customer’s bank.
As an aside, merchants will not clutter their pages with many payment buttons, so it is likely that there will be a rapid consolidation of Payment Initiation Service Providers. The network effect will ensure that those with access to the widest range of
banks will win.
Responses from card schemes
Given that PSD2 payments are potentially a threat to card payments, how are the card schemes reacting? At the moment their strategies look defensive – hedging their bets. In the UK, the Mastercard acquisition of Vocalink gives them a foothold in the non-card
payments space. Michael Miebach, Mastercard’s Chief Product Officer, said that VocaLink’s capability to make non-card payments via its Zapp mobile payments app will come together with Mastercard’s acceptance network. Meanwhile in the US, both Mastercard and
Visa have joined the bank-operated clearXchange P2P payments network. These moves position them well to leverage their assets to support non-card payments if PSD2 and similar initiatives prove popular. More cynical observers will also note that they could
also support an “embrace, extend, extinguish” strategy.
So, what next?
One of my fellow speakers, mindful of the old saying that "Prediction is very difficult, especially if it's about the future", admitted that no-one can say where payments will be in three years’ time. One thing is for sure: with global banks, merchants and
card schemes all fighting for pole position, the payments landscape will be very different. There will be winners and losers, and we can but hope that when the dust settles, consumers and companies benefit from new and more effective ways of making payments
and doing business.