By Trystan Tether


The mobile phone has rapidly become much more than a device for making voice telephone calls. With ever-changing technology, mobile telephone operators are developing new revenue streams as customers and operators in the mobile telephone industry take up new products and services which can be accessed through a mobile handset. One application with great potential is the use of the mobile phone as a convenient, efficient and widely accepted method of electronic payment.

The micro-payment gap

There is currently a significant gap in the electronic payment mechanisms market. Larger value transactions are conventionally settled using credit or debit cards - the details of which are telephoned through or passed over the Internet. However, these payment cards have a significant processing cost associated with them and this cost makes them uneconomic for so-called "micro-payments" – payments of a few pounds or less. The result of this is that there is presently no widely accepted payment method for micro-payments.

The absence of such a system has a number of disadvantages. For example:

(a) the development of certain types of internet service is held back by the fact that there is no workable charging model for them. A magazine may have high potential on-line readership, but be unable to publish electronically while still extracting a per-issue price (funding on the basis of advertising revenue may not be sufficient, and a subscription-based model rules out the "casual" purchaser);

(b) physical cash is an imperfect and often inconvenient medium in an age where ease-of-use is becoming increasingly critical. How much more convenient it would be to pay for a bus ticket with a rapid (and largely automated) exchange of electronic impulses than having to find the right change or suffer the wrath of the bus driver for holding up a queue of other passengers; and

(c) the handling of physical cash can be an expensive process, involving not only the cost of counting and processing but also the cost of the security measures necessitated by holding, processing and transporting any significant cash amounts.

The opportunity for an electronic cash substitute

The above disadvantages of conventional cash create a window of opportunity for an electronic cash product. It is a window which a mobile-phone-based product appears exceptionally well-placed to exploit. After all, mobile phones are devices on which value can be, and already is, "stored" - for example, prepay phones will have the relevant prepaid call value stored on them. Mobile phones are becoming increasingly ubiquitous at multiple levels in the community – young and old, rich and poor – and, critically, the operators of mobile networks operate billing engines which have the ability to handle very small debits (e.g. a 10 second phone call) at very low cost (they are, thus micro-payment-friendly). Compare the position of a mobile phone operator with the position of a company seeking to build an electronic payment system from scratch. The latter company will need to acquire all the technical infrastructure and gain the trust and loyalty of a customer basis. The mobile operator already possesses both of these (even if the infrastructure may require some adaptation).

So, a significant opportunity, but not one which is entirely without complications. There are obvious technological and security issues which arise in relation to such a service (e.g. how are fraudulent debits to the customer's phone prevented). But these are a type of problem which operators are well used to solving – they need to have a secure system to prevent the abuse of customers' phone accounts already.

Rather more vexed are the regulatory issues which running an electronic money product may encounter. Of importance, particularly from a structuring perspective, are the implications of a recent EU Directive which we will call the "EMI Directive". This article now proceeds to take a brief look at some of the regulatory issues which must be confronted by a mobile phone operator who wants to provide an electronic cash product through its mobile network.

The key regulatory issues

The regulatory issues will vary according to whether an electronic cash product involves the customer being charged for goods and services purchased after they have been purchased or whether it involves the customer purchasing a store of electronic value prior to such value being spent.

Paying after spending

Suppose that a phone operator (mobile or fixed line) agrees to allow retail customers to buy products using its telephone service on the basis that the cost of those products will be added to the customer's normal telephone bill and discharged by the customer at the end of the month/quarter in the normal way. The operator then pays the retailer of the products and recovers the cost to it of doing so from the customer's next bill payment. From a regulatory point of view, the issue with this arrangement is whether the operator is providing a regulated form of "consumer credit". It is likely that some form of "credit" is being provided because the customer obtains goods before he pays for them. However, whether the provision of that credit is regulated will depend on the regulatory regime of the country in which the arrangements take place. In the UK, for example, although "credit" is involved, there is an exemption from a large part of the consumer credit regulatory framework for certain "credit" which is required to be discharged in one amount within a short period after its being incurred. In other jurisdictions the position can be different and the provision of credit by means of discharging liabilities to third parties may be seen as a form of regulated banking business.

Paying before you spend

A key commercial problem with any payment product where credit is provided (i.e. the cost of purchases is billed to the customer after they have been purchased) is one of credit risk. The operator takes the risk that the customer will not pay immediately and even that he/she may not pay at all (e.g. if he or she becomes bankrupt or disappears). For many types of customer, taking a credit risk will be unacceptable to the operator. Hence there is significant appeal for any product under which the customer buys a store of value upfront and is allowed to spend only up to the limit of the value which he/she has already paid for. Any such product also has the additional advantage for the operator that, until the customer spends the value purchased, the operator can hold, and earn income on, the float of the purchase proceeds. Such income can help defray the cost of providing the service.

This type of product raises a different regulatory issue. Regulators have, for many years, sought to protect the public from persons who take money from the public against a promise to repay it. In the UK, money taken on this basis is called a "deposit" and anyone who wishes to run a business of taking "deposits" from members of the public is required to become an "authorised institution" (this essentially means a regulated bank, with the addition of few other entities such as the Government and certain quasi-governmental organisations). The regulatory concern is that an unregulated person who takes deposits from the public may receive money from the public on the basis of its promises but then not pay it back. The deposit-taker might, for example, invest the deposit proceeds unwisely, and so become unable to pay the deposits back. Equally, its controllers might be persons of a fraudulent disposition who simply make off with the funds. Or it might be an organisation with inadequate security, systems and controls with the result that the funds may be stolen from it. The system of authorisation of persons allowed to take deposits is intended to ensure that those persons who are so authorised are initially examined and then continuously vetted by the regulator, all with a view to ensuring that problems of the kind referred to above are unlikely to arise.

Does a sale of electronic value involve "deposit-taking"?

In relation to an electronic money product where value is purchased before it is spent, there has, for many years now, been a debate as to whether such a product involves "deposit taking". On the one hand, there are those who argue that it is a straightforward purchase of an asset (albeit an intangible one constituted by "payment value"), and therefore no more in need of regulation than a purchase of a packet of sweets. On the other, are those who argue that purchasing electronic value is more akin to pre-funding a bank account before going shopping and that, just as the bank providing an account is regulated, so should be the issuer of the relevant electronic value. The second argument has always been sufficiently strong to pose a significant regulatory problem to the creator of any potential electronic cash product[1]. And the difficulties and expense of creating and maintaining an authorised bank are sufficiently major to mean that this is not an easy solution to the problem.

A new solution – the "Electronic Money Issuer"

Enter the "electronic money institution". The concept of an electronic money institution derives from the EMI Directive, adopted in 2000 and now in the course of being implemented in all EU states.[2] The idea is to allow an issuer of electronic money to avoid regulation as a "deposit-taking" institution (i.e. any requirement to become a regulated bank) but instead to require that such issuer comply with a new (and supposedly less onerous) regulatory regime created specifically for electronic money issuers.

So how does the EMI Directive deal with the deposit taking issue? As indicated above, the EMI Directive regulates electronic money institutions (“EMIs”). An EMI is defined by the EMI Directive to mean an undertaking or other legal person, other than a credit institution (such as a regulated bank) which issues a means of payment in the form of electronic money. Further, electronic money is defined to mean monetary value as represented by a claim on the issuer which is:

(a) stored on an electronic device;
(b) issued on a receipt of funds of an amount not less in value than the monetary value issued
[3]; and
(c) accepted as a means of payment by undertakings other than the issuer.

If a person is an EMI, they are exempt from the requirement to be authorised as a "deposit taker", but must comply with the regulatory regime applicable to EMIs instead.

Importantly, an EMI which is duly authorised in any one EC Member State has the ability to operate as an EMI in any other Member State subject to the giving of appropriate notifications and satisfying its home regulator that it has the ability to so operate (this being commonly referred to as a "passporting" provision).

The Regulatory Regime applicable to EMIs

So, if one wants to provide an electronic payment service with prepayments, there is now a route to regulatory compliance which is easier than creating an authorised bank. However, although it may be easier to obtain authorisation for an EMI than for a bank, there are nonetheless some hurdles to be overcome and an EMI is, in many ways, more restricted than a bank would be in how it carries on business after its creation. For example, an EMI is restricted from carrying on any business other than issuing electronic money and certain other closely connected activities. In particular, under no circumstances is an EMI permitted to grant credit. For a mobile network operator this means that it would be necessary to establish a new group entity to issue electronic money and that this could not do be done through the operator itself.

Additionally, an EMI is strictly constrained in relation to how it can invest the float of monies generated by issuing electronic money (i.e. the funds held representing payments for electronic value which has been issued but not yet redeemed). This float can only be invested in particularly safe forms of investment (e.g. OECD country government bonds) which must also have a high degree of liquidity. There is a spectrum of types of permitted investment, but even the more "risky" end is relatively safe.

An EMI must also maintain a minimum amount of capital. The initial minimum capital is €1 million but as a further stipulation, an EMI must at all times have capital at least equal to 2% of its outstanding electronic money liabilities. This figure effectively rises (up to a potential 5%) if the float is invested at the more risky end of the spectrum of permitted types of investment.

Finally, an EMI must satisfy the regulator who authorises it (both initially and on an on-going basis) as to such things as the security and reliability of its systems (in relation to which an external consultant's report will often be required), the suitability and competence of its management and its compliance with statutory requirements regarding such matters as money-laundering.

Can even regulation as an EMI be avoided – the waiver provisions

It can be seen that obtaining regulation as an EMI is not an entirely simple or purely administrative process. Indeed, it was recognised in the course of the formulation of the EMI Directive that it was a process which might be disproportionately burdensome for a small operator of an electronic money product. With this in mind, the EMI Directive permits EC Member States to allow entities in their jurisdiction to operate on the basis of a "waiver" (i.e. they do not require regulation at all), provided that their product complies with certain requirements. An overriding requirement is that the electronic storage device on which each customer holds its electronic money must be subject to a maximum storage amount of €150 (thus limiting the exposure of the customer to issuer default to this amount), but one of the following conditions must also be fulfilled:

(a) the activities of the issuer do not generate total liabilities with respect to the issue of the electronic money which ever exceed €6 million and do not normally generate such liabilities in excess of €5 million; or
(b) the electronic money issued is accepted in payment only by persons who are members of the same corporate group as the issuer; or
(c) the electronic money issued is accepted only by a limited number of institutions which can be clearly distinguished by:

(i) their location in the same premises or other limited local area (e.g. a particular shopping mall); or
(ii) their close financial or business relationship with the issuing institution, such as a common marketing or distribution scheme.

Adoption of the waiver provisions of the EMI Directive by any Member State is optional, so different Member States of the EC are free to choose whether or not to adopt them and, if they do adopt them, upon what conditions. In the UK, for example, the waiver provisions have been adopted, but an application for "waiver status" must still be submitted to and accepted by the FSA. It should be noted that the "passporting" provisions referred to earlier do not apply in relation to institutions relying on the waiver provisions.

It is clear that the waiver provisions are sufficiently limited that they will not be useful to a mobile operator wishing to run a large scale "full service" electronic payment scheme for the benefit of all its customers (note in particular, the maximum liabilities limit at €5/6 million. However, they may be useful in the early "trial" stages of the operation of such a product or while any electronic money issued has a limited use (e.g. for purchases from companies in the same corporate group as the operator).

Two problems

So, on the face of things, the EMI Directive is welcome news for a mobile operator considering a mobile payment product. But it is not all good news. There are two particular problems which are worthy of mention:

(1) it is not entirely clear that the value issued by a mobile phone operator as part of such a product is properly defined as "electronic money"; and
(2) the EMI Directive poses a new problem for the use of prepaid airtime to pay for services supplied by persons other than the mobile phone operator itself – e.g. premium rate calls.

Is value issued under a mobile phone operator scheme "electronic money"?

An electronic money system operated by a mobile phone operator would be likely to be marketed on the basis that the customer would pay for value to be "loaded onto their phone" which could then be spent from the phone. However, in reality, value purchased by customers would not really be "held on the phone" as such. Each value purchase would result in the crediting of a central account of the customer with the phone operator and payments, although initiated by key strokes on the phone, would be effected by the operator debiting this central customer account and crediting an account of the payee merchant. This arrangement has many similarities to the operation of a bank account by the operator for the customer. The key question, however, is whether, notwithstanding such similarities, the electronic value which is "issued" under such an arrangement should nonetheless be treated as "electronic money" under the EMI Directive[4].

There is a difficulty with the wording of the EMI Directive from this point of view. In particular, when the concept of "electronic money" to be permitted and regulated under the Directive was framed, the draftspersons seemed to have had in mind a system under which value was loaded onto a smartcard device or hard drive and could be spent off that device without the need to resort to the giving of instructions to a centralised payment administrator (this being a type of technological approach adopted by the Mondex product). This impression is reinforced by the recitals to the Directive which refer to electronic money being a "surrogate for notes and coins". Notes and coins can, of course, be spent by the simple exchange of the units themselves without the need for the debiting and crediting of centralised accounts with a third party. This approach also found expression in the definition of "electronic money" itself which must be value "stored on an electronic device".

The question then becomes whether value which is stored on a centralised account-recording system for a customer is "stored on an electronic device" even if that particular device is not one in the possession of, or under the direct control of, the value purchaser. It could be argued that this was not the intention of the Directive.

On the other hand, the EMI Directive expresses an intention to be "technology neutral" in relation to the various ways in which an electronic money product may be created from a technological point of view. It would certainly seem to be far from "neutral" if a system was deprived of the benefit of the regime altogether merely because value transfers under it required the intermediation of the operator's computer. It is also significant that, of the main schemes currently being promoted in the UK market as forms of "electronic money", virtually all operate on the basis of there being a centralised account.

No doubt with this in mind, the FSA has made it clear that it will treat this "account-based" type of scheme as involving the issue of electronic money (and therefore not as a form of deposit-taking which would require regulation as a bank). The position of some other EC state regulators is currently less clear.

Can prepaid airtime become electronic money?

Mobile phone operators offering prepay phones receive money from their customers which those customers pay over in anticipation of telephony services being provided by those operators in future. Although money is handed over in advance of the provision of the service, this does not involve "deposit taking" (which, as noted earlier, requires banking authorisation) for two reasons:

(1) the customer has no general right to repayment of the monies paid over (repayability being a key feature of a "deposit"); and
(2) the relevant monies can only be expended in the purchase of the telephony services of the relevant operator and there is a specific exemption from deposit-taking for situations where money is paid in advance for the services of the payee.

The introduction of the EMI Directive has, however, now raised the possibility that prepayments on mobile phones may, in certain circumstances, become a form of "electronic money". Prepayments which can be used only to pay for airtime supplied by the operator receiving the prepayments do not fall within the definition, because it is one of the requirements for "electronic money" that it should be "accepted as a means of payment by undertakings other than the issuer". However, the position is less clear if an operator agrees that services other than the pure provision of standard rate airtime can be billed to a prepaid mobile. Particularly unclear is the situation in relation to premium rate services where it may be argued that some part of what is billed is a payment for the service provided by the content provider (who may very well be an entirely different entity from the operator) and a separate part is payment for the airtime enabling the delivery of the service.

The EMI Directive offers no assistance on this point. For the purposes of UK regulation, however, the FSA has recently published guidance on this issue in the form of Consultation Paper 172, “Electronic Money: Perimeter guidance” (February 2003). In essence, the FSA is prepared to take the view that prepaid airtime used to pay for premium rate services will not constitute "electronic money" provided that:

  • the supply of telecoms services by the mobile airtime provider and the supply of services by the relevant premium rate service providers can be seen as a single service; and
  • the supply of the airtime and the supply of any premium rate service supplied against payment in prepaid airtime value take place in the same action.

This clears the uncertainty in relation to premium rate services which are provided exclusively through the prepaid mobile itself (e.g. a "traffic report" dial-up service). It may well pose problems for more innovative arrangements.

The way forward – is current regulation too onerous

As noted at the beginning of this paper, the opportunities for mobile phone operators to provide highly successful electronic payment services are significant. The EMI Directive has provided an alternative to regulation as a bank which is promised to be significantly more relaxed in terms of initially obtaining authorisation and ongoing compliance.

But the burden of compliance is nonetheless significant. And it has to be remembered that the amount which customers are prepared to pay for payment services is generally limited (the use of cash costs the customer nothing and so this is their starting point for any cash-alternative). Any cost of regulatory compliance therefore has a high risk of impeding product development.

Critically, the EMI Directive has made matters significantly worse in one important respect. If a prepaid customer is allowed to use their prepaid airtime to make purchases other than of services delivered via the phone, it is now arguable that the prepaid airtime itself becomes a form of "electronic money", with significant regulatory implications. Further complication is added by the fact that not all Member States in the EC are interpreting the EMI Directive in the same way, creating considerable regulatory uncertainty for a pan-European operator.

These factors are, without doubt, deterring mobile operators from the creation of new payment products and the EMI Directive's existing "waiver provisions" are too restricted to provide a way around the problems (noting in particular the €5/6 million maximum discussed above).

The inevitable question is whether the burden of regulation is stifling the sensible commercial development of small-value payments using mobile phones. And there is a strong argument that it is. In particular, is it really necessary to prevent an operator from allowing its prepaid customers to make small-value payments simply using their prepaid airtime and without requiring the creation of complex separate EMI arrangements? Do customers of large mobile phone operators really need that much protection against the operator's potential insolvency?

Of course consumer-protection is important. But if consumers do not receive a product which could benefit them on the grounds that regulators are not prepared to let those consumers take a £100 credit risk on some very large companies (to whom those consumers already have (and willingly accept) credit exposure on prepaid airtime), does the balance not need to be shifted?

Written by Trystan Tether and Anthony Olsen.

[1] For a mobile phone operator, this problem is greater because any electronic cash product which it creates with a link to a mobile phone is likely to involve the pre-funding of an identified account. This has much greater similarities to "deposit taking" than the type of arrangement where, for example, system-users buy anonymous disposable cards pre-loaded with value.
[2] The EC Directive on the taking up, pursuit of and prudential supervision of the business of electronic money institutions (No 2000/46/EC).
[3] Although the words from "of an amount not less…" to the end have been deliberately omitted in the UK's implementation of the Directive.
[4] Remembering that, if it is not, it may be seen as a form of "deposit taking" or, in some jurisdictions, might escape regulation altogether.