Changes introduced to EU law in recent years support diversity in the market, and further innovation is likely as the EU's second Payment Services Directive (PSD2) beds in. Those companies which can respond fastest and shift their business models to make the most of regulatory developments invariably receive a first-mover advantage.
Additionally, mobile payment providers from the EU, US and China have focused on collaboration as a driving force in their campaigns to gain European market share. Investment in joint ventures, alliances with traditional financial institutions and extensive corporate contracting efforts have been prevalent, rather than the direct winner-takes-all competition that many anticipated a few years ago.
Growth in popularity of the smartphone and its part in our daily lives is one of the major drivers of the mobile payments market. It is little surprise, therefore, that the technology companies at the heart of smartphone systems and software have taken an interest in mobile payments.
Together, Apple Pay and Google Pay have an estimated 350 million users across the world. While the bulk of these users are in the US, the services have been available in parts of the EU for a number of years.
Both Apple Pay and Google Pay operate by overlaying the card schemes, where card issuers, merchant acquirers, MasterCard/Visa and the technology companies themselves all play a role in the processing of transactions
To their advantage are their vast existing customer bases and data management systems which allow these companies to successfully negotiate with card issuers to provide a new layer to existing payment schemes. Users can make payments seamlessly using the technology company's software which helps reduce the friction in the payment for services and goods online or in-store.
Google recently expanded its payment market options by becoming an e-money institution (EMI), licensed in Lithuania, following other technology companies like Amazon and Facebook in becoming an EMI in the EU. EMIs registered in one EU country have 'passporting' rights to offer the same service in other member states.
In return for receiving funds, EMIs issue e-money – electronically stored value – which can then be used to pay for goods and services. Again, payment is often effected using the existing payment schemes. An advantage of e-money when it is transferred between customers of a single EMI is that the value does not need to pass through the bank or card systems. A transfer in these circumstances simply results in an accounting adjustment within the EMI's records. A recipient can then decide how they want to use the e-money that has been credited to their wallet.
Google also became licensed to issue payment instruments and/or acquire payment transactions by the Central Bank of Ireland under PSD2 in December 2018.
Among other things PSD2 introduced two new kinds of payment services: payment initiation services and account information services. Payment service providers that gain approval to carry on these new services can, with user permission, respectively send payment orders to facilitate debit transfers, or request account information from, users' payment account providers. Technology companies will undoubtedly look at these new payment services and consider whether software can be developed or adapted to provide them in a seamless fashion. They will also consider the infrastructure requirements for payment service providers and compare the compliance burden against other forms of regulation and consider whether this now provides an attractive avenue to market.
We may yet see further applications from the technology companies to become a payment service provider.
It is not only US companies that are looking to increase their share of the European mobile payments market. Chinese e-commerce and social media giants Alibaba and WeChat are also making investments. While they are relatively unknown to European consumers, they have been entering the market through Chinese tourists and Chinese people living abroad who already use their products.
China is the undisputed world leader in mobile payments. In parts of the country, the use of cash has been almost entirely replaced by Alipay and WeChat Pay. From a regulatory perspective, the equivalents of the EU's second Electronic Money Directive (2EMD) and PSD2 have been in force in China since 2011, and the clout now wielded by the leading mobile payment apps has grown so fast that a compulsory clearing house has been established in order to maintain financial stability.
In China, Alipay and WeChat Pay hold customer funds, like EMIs, but have also created a model for in-store payments which could be described as a parallel track to the traditional card system. QR codes are a recognisable feature of the infrastructure-light in-store payments model used by Alipay and WeChat pay.
Alipay first began operating in Europe in 2015, partnering with local card acquiring services to enable Chinese tourists to pay for goods using their Alipay account. WeChat Pay launched a rival service in 2017.
Like their US rivals, however, they have recognised the contracting burden which comes with this process of expansion. Li Wang, head of Alipay in Europe, the Middle East and Africa, has been quoted on the process of "making more friends", saying: "Local banks with a long history are major players in the countries, although each of them occupies comparatively minuscule share of the whole market, unlike in China where the top 10 banks take up 60-70% of the market share."
It is against this background that Alipay acquired an e-money license in Luxembourg in January 2019.
Whilst the expanding Chinese tourist market in Europe continues to be lucrative to Alipay, it can now offer its services across Europe to the domestic mobile payments market. It is only a matter of time before WeChat Pay follows suit. Both companies can quickly extend their existing payments architecture to the EU and accommodate a rapid growth in European transaction volume.
Some of the most successful companies to emerge onto the EU's mobile payments market have been home-grown start-ups.
Companies such as Revolut, Transferwise and Stripe have targeted different sub-sectors of the payments market, such as foreign exchange, remittance and in-store transactions. They have expanded from conception to 'unicorn status' within only a few years.
The 2EMD has enabled companies to provide innovative stored value products without the same capital burden which incumbent banks operate. PSD2 will also likely allow for rapid growth in the next generation of mobile payment competitors.
Unlike the US and Chinese tech companies, the home-grown European fintechs have concentrated their efforts to-date on consolidating within a single country or group of countries.
The growth of the payments industry was previously heralded as a signal of the 'unbundling' of banking, or the breakup of the traditional banking service into several industries, but some fintechs such as Monzo, Klarna and N26 have gone on to 'rebundle' an array of products and become authorised as banks. Each now operates as the leading 'neobank' in a different EU member state, but have limited reach internationally.
Consolidation may simply be one phase within a larger campaign of expansion. Whilst EU legislation has done much to lower the barrier to entry into this competitive market, expansion still brings regulatory, operational and cultural challenges which the world's largest tech companies are perhaps better equipped to meet than smaller emerging European fintechs. Revolut coming under scrutiny concerning its sanction screening procedures is a recent event highlighting the compliance challenges that can arise as businesses grow.
Central aims of the PSD2 reforms are the opening up of the EU's payment services market to greater competition and innovation. In practice, this is being achieved by fintechs in a number of different ways.
Whilst some of the more mature fintechs such as Monzo have begun to compete with incumbent banks, many others have entered into partnerships with traditional financial institutions to enhance the services offered to the customers of those institutions. Examples include the collaboration between Bud and First Direct, which is part of HSBC, and the relationship between Tink, a Swedish PSP, and SEB, ABN Amro and BNP Paribas Fortis.
The youngest European fintechs, lacking both user base and capital, are working with incumbent financial institutions in order to find more direct routes to market share by leveraging their partners' existing customer base.
The importance of collaboration and alliance-building to rapid growth was highlighted in a recent report by Pinsent Masons, the law firm behind Out-Law.com. It found that of Europe's fastest-growing financial services companies, 88% had taken a minority stake in another company, 74% had a licensing or franchising agreement in place and 72% were engaged in an equity joint venture.
Looking to the future
It is clear that regulation can and will continue to drive innovation. Those companies which can respond fastest can win market share while their rivals are still developing new products or business models. Companies aiming to increase their share of the market have been strategic in shifting their business and operating models to take advantage of the developing legal framework. Recent registrations with European financial authorities are likely to be copied by other global companies, and the lighter infrastructure afforded by PSD2 may increase the speed at which new mobile payment products can be brought to market.
The list of start-ups which have become unicorns since 2011 is testament to the impact of 2EMD and the first Payment Services Directive. Just a year after the implementation of PSD2, Bud announced that it raised $20 million in Series A funding, signalling that the latest directive could have a similar impact on the mobile payments market. Particularly as traditional financial institutions seek to match the service provided by emerging rivals, M&A and other investment activity in the sector could become prevalent in 2019.
Legislation and investment aren't a replacement for an effective route to market, however, and it's likely that collaboration will continue to characterise the efforts of the world's most exciting mobile payment providers to service their existing and prospective European users. It is likely that competitors will develop increasingly innovative alliance-building strategies in order to leverage their existing strengths and maximise their product value.
Andrew Barber is a specialist in financial services regulation at Pinsent Masons, the law firm behind Out-Law.com.