Q1 | Torys QuarterlyWinter 2023

Payments push: trends in payments modernization and regulation in 2023

Payments methodologies are evolving and so are the systems that support them. As we enter the new year, companies continue to incubate and innovate new technologies and systems for payments while regulators and government try to govern them. Torys takes a look at what is on the horizon, from modernization to regulation, and everything in between.

Payments modernization

Payments Canada is responsible for the operation of the national clearing and settlement infrastructure and is currently in the process of implementing a new real-time payments system. The new system (referred to as Real-Time-Rail, or RTR) will be composed of two main components: 1) the RTR Exchange; and 2) the RTR Clearing and Settlement. The RTR Exchange will facilitate the real-time exchange of payment messages between participants, and the RTR Clearing and Settlement will perform the real-time clearing and settlement of transactions between participants.  On October 11, 2022, Payments Canada announced the need to revise the launch of the RTR in order to provide additional time to validate and test the components and end-to-end integration of the RTR system. They have not yet confirmed a launch date.

The RTR will provide for immediate benefits, including: 1) 24/7/365 availability; 2) real-time message exchange, where payment and transaction processing and settlement will be fully completed within seconds (i.e., in “real time”); 3) immediate payment finality for payors and payees; and 4) support for the ISO 20022 messaging standards (the data-rich global messaging standard that will serve to harmonize payment messages both domestically and internationally).

The new ISO 20022 is an opportunity to better understand user behavior and develop new customer-facing services and products that are responsive to customer needs.

For those businesses involved in the handling of payments, the use of the standardized ISO 20022 messaging format presents an opportunity to revisit their data strategy and optimize the most effective use of information handled through the messaging format. The ISO 20022 standard notably provides for significantly more data than other standards currently used to process payments. The new ISO 20022 represents a potential opportunity to better understand user behavior through data analytics, implement safeguards against potentially fraudulent behavior (through more robust fraud detection algorithms), and develop new customer-facing services or products that are responsive to customer needs.

Retail Payment Activities Act

In June 2021, the federal government enacted the Retail Payment Activities Act (the RPAA) to regulate entities that perform electronic payment functions, such as payment processors, digital wallets, money transfer services, and other payment technology companies that offer retail payment services. In the fall, the Bank of Canada (the BoC), which will supervise such regulated payment service providers (PSPs), released its supervisory framework in which it describes how it will ensure PSPs comply with the RPAA. 

The BoC supervisory framework consists of three activities: (a) registration, (b) risk monitoring and (c) enforcement.  Although additional details will be published in future guidance, the BoC provided the following details in its framework:

  • Registration - the BoC provided details as to the types of individuals or entities that will need to register and that a portal facilitating registration is currently under development. The PSP’s application will be shared with the Department of Finance to conduct a national security review and with the Financial Transactions and Reports Analysis Centre of Canada (FINTRAC). A transition period will allow PSPs whose application is being considered by the BoC to continue providing services.
  • Risk monitoring - the BoC will require PSPs to submit various reports, such as annual reports, new activities reports, and incident reports, to support the monitoring and assessment of their compliance with the BoC’s supervisory requirements. The BoC will also expect PSPs to respond to any additional requests that the BoC may have to assess the PSP’s compliance. The BoC may identify potential gaps in the PSP’s approach, in which case it will case require the PSP to implement corrective measures.
  • Enforcement - the BoC may conduct investigations to identify potential gaps in a PSP’s compliance.  To identify violations of the RPAA, the BoC may rely on previously submitted information, desk reviews, on-site visits and special audits. The BoC may use any of the following enforcement tools:
    • A notice of violation that could also include an administrative monetary penalty and an offer to enter into a compliance agreement.
    • A compliance order in which the BoC can order a PSP to stop an act that could have a significant adverse impact on end users, refrain from taking an action or remedy a situation.
    • Court enforcement whereby the Governor of the BoC can apply to a superior court for an order in response to a violation.

The next steps are the regulations, which are expected to be published for comments in 2023.

Non-regulated financial institutions enter the world of payments

In the fall, Wealthsimple, a Canadian fintech company, became the first non-bank, non-credit union, to be approved for a direct settlement account by the Bank of Canada.

Granting approval of a settlement account and eventual access to the real-time-rail system to an organization outside the regulated financial institution sector is a significant development. Wealthsimple will be able to expand its product offering to new services, such as payments options for businesses, instant wage and bill payments, and real-time cross border payments. This is also significant for other fintechs, as it opens the door to the possibility of others being granted the same access. Such access will become even more important once open banking launches in Canada and the real-time rail system becomes operational. If we look to the United Kingdom’s experience as a predictor, granting direct access to the U.K. payments system to non-banks in 2017 led to a surge in fintech product offerings. A similar outcome may also be around the corner in Canada.

Continued focus on credit cards

For decades, consumer groups and merchant organizations have tried to convince policymakers that credit card fees, surcharges and interest rates should be controlled or, at the very least, better regulated.

In 2022, businesses finally obtained, following a long-standing lawsuit, the right to charge consumers a credit card surcharge. Certain payment card network operators (PCNOs) will allow a merchant to charge a fee, which is capped at the costs the business faces up to a maximum of 2.4%. Merchants must clearly disclose to consumers the surcharges and fees, and the cardholder must have the option to cancel the transaction without penalty. However, in this rising interest rate environment, businesses may be reluctant to impose on consumers an additional charge—a recent survey by the Canadian Federation of Independent Business found that only 20% of their members expressed interest in charging the fee.

The government has announced that it intends to enter negotiations to lower transaction fees for small businesses.

Another avenue, one advocated by organizations such as the Retail Council of Canada, is for government to regulate credit card fees—a route that Australia and some European countries have adopted. It also seems to be getting traction in Canada. Minister of Finance and Deputy Prime Minister Chrystia Freeland announced in her fall economic update that the government intends to regulate credit-card transaction fees. The government has announced that it intends to enter negotiations with payment card networks, financial institutions, acquirers, payment processors and businesses to lower transaction fees for small businesses in a manner that does not adversely affect other businesses and protects existing reward points for consumers. The announcement states that should the industry not come to an agreed solution in the months to come, the government will introduce amendments to the Payment Card Network Act at the earliest opportunity in the new year and move forward on regulating credit card transaction fees.

New industry group pushes for fintech

A new industry group is taking payments to Parliament Hill. Fintechs Canada is a new advocacy group composed of traditional financial services providers and new and emerging fintechs. The group is hoping to shape the conversation on Canada’s financial services industry, including with respect to payments modernization, open banking, the digitalization of money, and the modernization of anti-money laundering and anti-terrorist financing laws. The new group is a sign of the push for continued modernization in the financial services space and provides a flavour of what the next generation of payments will look like in this country, including a mix of traditional players and new innovators.

Looking ahead

2023 will shape up to be a busy year for payments modernization in Canada, as industry will continue to innovate with new products, and hopefully, government will make further progress on its many initiatives.

To discuss these issues, please contact the author(s).

This publication is a general discussion of certain legal and related developments and should not be relied upon as legal advice. If you require legal advice, we would be pleased to discuss the issues in this publication with you, in the context of your particular circumstances.

For permission to republish this or any other publication, contact Janelle Weed.

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