On 15 July 2024, the Financial Conduct Authority (FCA) and the Payment Services Regulator (PSR) published a call for information (CFI) on BigTech and digital wallets, which runs until 13 September 2024. The CFI notes that the share of retail payments involving a digital wallet in the UK is growing (estimating that 14% of point-of-sale terminal transactions and 38% of e-commerce transactions, by value, involved a digital wallet in 2023) and as such, it is no surprise that regulators have been eager to better their understanding of how digital wallets are used. The CFI builds on the FCA and PSR’s previous publications on BigTech and mobile payments, which date back to 2018. The questions in the CFI suggest the FCA and PRA are considering a range of issues, including whether:
- digital wallets are working well for consumers, businesses and other users of payments;
- there are any disincentives or other barriers to digital wallets integrating account-to-account payments; and
- stakeholders consider that digital wallets raise any significant consumer protection or market integrity issues.
At this stage the regulators are only gathering information, but they appear to be focussed on assessing (i) the benefits and risks of increasing the use of digital wallets, (ii) whether digital wallets could be used to support alternatives to card payments and (iii) whether the current approach to regulating digital wallets is effective.
What is a digital wallet?
Digital wallets are loosely defined in the CFI as “apps, software or online services that allow consumers to make payments quickly and conveniently, using mobile phones or other electronic devices.” That covers a whole host of digital wallet types that rely on completely different technologies. The CFI cites “pass-through digital wallets” and “staged digital wallets” as two types of very different wallets which would both be captured by the CFI’s definition.
- Pass-through digital wallets, which are the most popular type of digital wallets in the UK, enable card payments through other devices. The providers of pass-through digital wallets do not hold funds themselves. Instead, the key services they provide are card tokenisation services. Depending on the other services they provide, the operators of pass-through digital wallets may not need to be authorised (the CFI notes that “[a] provider of a mobile app that transmits a payer’s tokenised card details with a payment order for processing by another firm that is a payment service provider is not carrying out the FCA-regulated activity of issuing a payment instrument.”).
- Staged digital wallets typically follow a two-stage process, where funds are first added to the payer’s digital wallet (from their bank account) as e-money. Subsequently, at the point of purchase, funds are transferred to a recipient’s digital wallet account, from which it can be withdrawn to the recipient’s bank account. Staged digital wallets are sometimes referred to as “e-wallets” and are likely to need to be provided by authorised e-money, payment or credit institutions, unless there is a relevant exclusion.
Do the benefits of digital wallets outweigh any associated harms?
Given the increasing popularity of digital wallets, the FCA and PSR are interested in the advantages they afford users. The CFI identifies several consumer advantages including that digital wallets allow consumers to make payments quickly and conveniently using mobile phones or other devices. The CFI also notes that there may be security advantages to making payments through a digital wallet rather than a physical card – for example, if a consumer loses their phone and it is locked, a person finding it should not be able to make fraudulent purchases. The FCA and PSR are also interested in how digital wallets could benefit other stakeholders including card schemes, issuers, and retailers.
The FCA and PSR ask a range of questions in the CFI to better understand the fee structure associated with digital wallets, in particular whether they provide fair value to customers, and also requesting more information about any adverse outcomes experienced by service users. Whilst the CFI notes that the main digital wallets do not typically charge consumers fees directly, that does not preclude the possibility in the future, or that revenues could be earned in other ways. We note that a subset of questions in the CFI explores the possibility that customer data linked to their digital wallets is valuable and could be combined with other insights BigTech companies may have on users.
Could digital wallets be used to support alternative to card payments?
The CFI includes a chapter which considers how digital wallets could impact competition with payment systems and the factors that might impact adoption of account-to-account payments in the UK.
Currently, most of the digital payments made in the UK are underpinned by card payment rails. Alternative payment methods, such as account-to-account payments that leverage open banking technology, are less common. One of the PSR’s strategic priorities is to increase competition by “unlocking the potential” of alternative methods, including account-to-account payments.
The CFI indicates that based on recent data, pass-through digital wallets, which are underpinned by card payment rails, are the most popular form of digital wallet in the UK. Based on the information cited in the CFI, in 2022 digital wallets had been used by 47% of UK adults as a payment method in the previous 12 months. The two most popular digital wallet providers in that timeframe exclusively offered pass-through digital wallets.
Staged digital wallets that are integrated with account-to-account payment systems are successfully being used in other countries like India, China and Spain. Whilst there may be differences with the UK due to consumer preferences and habits, the CFI takes note of the success of account-to-accounts payments in those other jurisdictions. The PSR and FCA go on to suggest that these examples may provide insights into how other forms of digital wallets could grow in popularity as the proportion of UK consumers using digital wallets increases over time.
However, the CFI notes that there may be a number of reasons why digital wallets might continue to prioritise payments underpinned by cards rather than account-to-account payments. On the customer side, card payments benefit from certain consumer protections, as underlying card issuers remain responsible for unauthorised transactions made via pass-through digital wallets. The CFI also notes that some pass-through digital wallet providers charge issuers for initiating card transactions and those providers may be reluctant to forgo this income stream. Other disincentives to integrate account-to-account solutions could include the need to become an authorised payment initiation service provider or to make UK-specific changes to the wallet offering. The FCA and PSR are keen to understand any disincentives against enabling account-to-account payments as an effective alternative to card payments. To that end, the CFI asks respondents for information on how account-to-account services could be integrated in the future by digital wallet providers and how digital wallets could best develop to encourage effective competition between payment systems.
How are digital wallets currently regulated, and could that change?
Certain digital wallets are currently within the FCA’s regulatory perimeter. The FCA looks to the substance of a digital wallet product to determine the appropriate regulatory requirements and as such, it is a fact-specific analysis. However, there is a particularly helpful exclusion noted in the CFI for technical service providers, which means that certain digital wallet providers (typically pass-through wallets) do not need to be regulated by the FCA. However, depending on the other types of service provided, digital wallet providers may fall within the FCA’s remit – e.g., when providing account information via a dashboard on the digital wallet’s app, providing account-to-account payment initiation services or e-money issuance.
The PSR is the economic regulator of payment systems in the UK and its powers extend to regulated payment systems and participants in such systems. Whilst there have not yet been any digital wallets designated as a regulated payment system, the PSR’s view appears to be that this is possible (depending on the services provided and the way they operate). The CFI also notes the PSR's view that digital wallets could be characterised as “participants”. However, this is caveated, as it will depend on the services provided.
It is also worth noting that the CFI calls out that digital wallet providers could develop new types of payment services that are unregulated and if such new services become widely used, these may increase the risk of consumer harm. The implication of referring to such services is that the FCA (and potentially the PSR) would consider how best to regulate such services to minimise consumer risk.
The CFI also notes the FCA and PSR’s concurrent competition powers which allow the regulators to address competition harms which arise beyond their respective regulatory perimeters.
Financial resilience and consumer harm
The CFI includes a short chapter on operational resilience – an increasingly hot topic. Currently, the FCA does not seem to be overly concerned about the impact that digital wallets pose to the wider financial system, because if a digital wallet service did stop working, whilst it would cause disruption, service users could fall back on physical payment cards.
However, the CFI identifies that there is a risk that over time, the need to issue physical payment cards might diminish. In that scenario, a digital wallet’s operational failure would pose a greater threat to the broader financial system as a physical card would not be a reliable fallback option. Building on that hypothetical scenario, the CFI suggests that pass-through wallet providers might need to develop alternative business models that do not rely on existing card schemes or payment rails. Those changes could bring pass-through wallet providers into the scope of the FCA’s regulatory remit, which would allow the FCA to impose a regulatory framework capable of minimising any consumer risks associated with new business models.
By contrast, the CFI suggests that the risk of consumer harm is greater where electronic money is held by a staged digital wallet provider, or where a staged digital wallet offers account-to-account services. However, the CFI indicates that appropriate oversight of staged digital wallets may already be in place as such providers already fall within the FCA’s regulatory perimeter (in the absence of an applicable exclusion).
Unauthorised transactions and data breaches
The CFI asks a number of questions about security and related matters, to gather information regarding the ability of digital wallet providers to protect users against unauthorised transactions and data breaches. Under the current framework, pass-through wallet users are protected by the underlying payment card issuers against the impact of fraud (rather than the digital wallet providers themselves). The FCA and PSR are keen to understand how this allocation of responsibilities functions in practice. A number of questions in the CFI encourage respondents to comment on whether digital wallet providers adequately protect their users against the impact of fraud.
The CFI notes the potential “myriad benefits for consumers” that may arise from the convergence of wallets and accounts through the use of open banking services (e.g., open banking products that consolidate a consumer’s financial data in one location). However, the regulators are also aware of the challenges posed by these kinds of digital wallets – noting by way of example that the risk of a data breach increases when more financial information is shared between different parties. As such, the CFI also asks questions about the potential impact of digital wallets integrating with open banking, e.g., on user access to financial services, security and privacy.
Final thoughts
The proportion of UK adults that have used a digital wallet in the previous 12 months rose from 14% in 2017 to 47% in 2022. That growth seems likely to accelerate as digital wallets are particularly popular with younger customers. In light of that trend, the FCA and PSR are seeking information from stakeholders which is clearly in line with their respective objectives (particularly in relation to innovation and consumer protection) by anticipating different ways that digital wallets are likely to be used in the future. They intend to publish an update by Q1 2025 and expect that this work will inform the regulators’ continued engagement with the CMA on digital market issues. We await that update for a better sense of (i) the ways in which the FCA and PSR might seek to reduce any perceived disincentives in integrating account-to-account payments and (ii) how the current regulatory approach (including to currently-unregulated services) might shift in the future.