Long reads

European sovereignty shackled to its payments

March 2014: in the midst of the diplomatic crisis following Russia's invasion of Crimea, some Russian dignitaries were deprived of payment methods without warning. They were unable to withdraw cash or make purchases. The "perpetrator" was the U.S. government, which ordered Visa and Mastercard to freeze transactions from a handful of Russian banks in which certain politicians held their accounts.

Two independent, privately-owned companies listed on the stock exchange were thus able to swing the axe of American diplomacy on a simple government order. In a world watching day by day as multilateralism melts like snow in the sun, this retaliation cannot be described as incidental.

In fact, Visa and Mastercard are a global duopoly through which the vast majority of bankcard transactions pass and without which hundreds of millions of merchants and businesses could neither work nor get paid. This is indeed an essential component of the economic health of each country and therefore of its sovereignty.

Energy independence and food independence are viewed as strategic considerations, but "payment independence" is systematically neglected. We believe that it is a fundamental mistake because this issue is at least as important as the first two: payment services are omnipresent in our economies and have no alternative (unlike food and energy which can be provided by many potential suppliers).

In a post-COVID-19 world that is hastening the transition from cash payments to card payments, the reliance on payment systems is only getting stronger. One country that would use mainly the technology of another for its payments would therefore be at the latter's mercy. This is now the case for Europe and the United States, respectively. The US also has no need to make a threat - the mere possibility of this threat puts pressure on its "partners". At the international diplomacy game, you don't have to use the ace when everyone knows you're holding it. For Europe, this is a structural vulnerability. In a world that is further divided every day, this tension could become critical.

There is another threat - the threat of access to data. Transactions that pass through the Visa and Mastercard networks constitute highly sensitive information. Today this data seems partitioned and anonymous, but government authorities are already putting pressure on payment providers to access it. It could one day spark malicious interests or turn into strategic intelligence. Lastly, the exponential development of "wallets" such as Google Pay and Apple Pay has created a new value-chain segment dominated by foreign players.

Since the 2014 episode, Russia set up its own payments network in order to free itself from dependence on the United States. China did the same with a 100% Chinese network, UnionPay, which has become the world's largest bank-card network. Japan also uses a domestic network (JCB), but not exclusively.

A vital project

In this context, Europe seems vulnerable and isolated. The majority of domestic operations pass through Visa and Mastercard networks (and almost all international transactions). The weight of both U.S. networks represents 75% of local operations. This figure was 50% ten years ago, a sign of the technological obsolescence of local alternatives. That is why we must welcome and encourage the EPI (European Payments Initiative). Driven by private players (mostly banks) and approved by the ECB, it aims to create a pan-European payments network replacing Visa and Mastercard for domestic payments. It would cover a large portion of the value chain ranging from peer-to-peer payments to wallets. This project is valuable and vital for the future of Europe.

But as critical as it is, the success of the EPI project is still very uncertain. It will face two kinds of challenges - technical and commercial. The technical challenge will likely be overcome, as investment in this area is very high (to the tune of several billion euros) and the initiative can capitalise on TIPS - the instant payment technology already developed by the ECB. The commercial aspect is much harder to gauge. Merchants and cardholders will have to be convinced the new network is useful. On the merchant side, network fees (the commissions paid to Visa and Mastercard) could decrease, but this may not be enough for them to make a change.

Similarly, on the end-user side, habits are slowly changing in the payments sector and migration to an EPI card (which will be co-branded by Visa and Mastercard for payments outside Europe) may take time. That is why it is difficult to estimate the success of the EPI as long as the current domestic networks – Bancomat, Cartes Bancaires, Girocard, etc. – remain.

If the EPI keeps its original ambition and does not limit it simply to interoperability, each country with its own network will have to agree to eliminate it. This will force all market participants – merchants, banks and customers – to switch to the new network. This is a major concession, particularly for France, which benefits from a robust and inexpensive platform with Cartes Bancaires. EU countries will therefore have to choose between preserving a proprietary domestic network and adopting a European network guaranteeing true sovereignty. This is the price of a truly independent Europe.

As part of its strategic review, the European Commission recently began discussing mandatory implementation of the SEPA Credit Transfer scheme (instant payment), which could fit perfectly within the EPI framework particularly with the development of bank "wallets". As far as banks are concerned, the ball is now in their court. They will have to decide between maintaining the current system, which is very profitable but has no future, and taking the risk of investing in building a new payment infrastructure that would enable them to stay in the ecosystem sustainably.

The EPI also has a major financial incentive. Today, the world's three largest payment service providers (PSPs) are American. Their combined market capitalisation exceeds $200 billion ($240 billion including Stripe) compared to almost a third of that figure for their European counterparts ($80 billion). The level of profitability for US players is also significantly higher (45% margin versus 25% in Europe for similar activities), offering them the luxury of investing in their technology and maintaining a virtuous circle. In a sector where size is a crucial competitive advantage, this gap is a major handicap for European companies and European regulatory fragmentation is one of the main culprits.

As the track gauge differs from one EU country to the next, local players cannot benefit from the scale effects of their US competitors on their domestic market. In our view, the EPI must make it possible to harmonise European rules and for the European champions that are currently lacking to emerge naturally. Europe has the chance to protect many legitimate candidates for the status of world leader in payments, including Worldline, Nexi, Adyen, etc. It merely aims to give them the means.

Comments: (2)

A Finextra member
A Finextra member 19 November, 2020, 10:33Be the first to give this comment the thumbs up 0 likes

Interesting optic to apply to the MasterCard take-over of VocaLink?  And PSR's role in this.

A Finextra member
A Finextra member 19 November, 2020, 16:49Be the first to give this comment the thumbs up 0 likes

Thanks Aymeric for the interesting post.
Another case similar to the 2014 one you mentioned, is when SWIFT - despite being a European legal entity - has been forced to keep providing its data to the NSA, including PII of European citizens, as disclosed back in 2006. 
I do agree with your perspective on the need of a European schema, the real problem being the economies of scale needed by a new international circuit to successfully compete with existing ones, as you pointed out.
I wonder if adopting a 4- or 3-corners model based on a CBDC like the Digital Euro could help solving this conundrum.