Rules of the Road: Interoperability and Governance
The brand decals of today’s most well-known payment schemes — such as Visa, Mastercard and China Union Pay — let billions of people know that their credit or debit cards will be accepted at stores and ATMs all over the world. The organizations behind these brands often facilitate the actual switching of payments between financial institutions as well. However, these schemes provide more than a switch, or even a brand: They define the way their members will interact with one another through a set of governance rules.
The companies we know today as Visa and Mastercard grew from an association of banks that collectively agreed to the terms needed to safely and efficiently exchange payments, from interparty pricing to recourse procedures for fraudulent transactions. Similar rules are in place today for any bank that is a member of these popular card schemes but also for institutions that use payment channels such as Automated Clearing House or Electronic Funds Transfer.
Such governance rules are a necessary ingredient for interoperability. They define the power structure and the way decisions will be made by participants. They set the rules of the game and ultimately the terms for how competitors will collaborate. For today’s digital financial services (DFS) schemes, those facilitating the types of small-dollar, real-time payments most frequently used by the poor, such governance rules, are frequently absent or incomplete. That might mean fewer protections for consumers or insufficient incentives for providers to push transactions through the system.
Where scheme rules for DFS exist, some have been created by regulators as part of top-down mandates, others have been formed by industry associations or newly formed entities, and still others have been created independently by industry participants. One of the more complete sets of DFS rules was developed by participants in the mobile network operator (MNO)-led scheme in Tanzania. An example of these rules are open source under a Creative Commons license and can be downloaded by anyone from the IFC interoperability website.
Scheme governance rules will look slightly different in every scheme, but there are a few universal elements of well-defined rules:
First and foremost, scheme rules set the membership criteria — who is allowed to join the club. For popular card schemes like Visa, Mastercard and China Union Pay, this means being a bank and paying an enrollment fee. For DFS, it can mean different things depending on the market. National Payments Corporation of India scheme members in India (i.e., institutions connected to the India Stack) must be banks but are otherwise free to join. Members of the industry-led scheme in Tanzania are not held to the standards of a central authority but must have a commercial agreement with at least two current members to join.
The qualifying criteria of membership are important not only because they determine who is in and who is out, but because they often have a significant role in setting the terms for participation.
Participation in rule-setting
Will decisions be made by members on a one-person, one-vote basis or as a percentage of ownership or by other terms entirely? These are the types of factors addressed by rules on governance participation. In the Tanzania MNO scheme, each member gets a single vote regardless of size, and a 75 percent majority is required to change the rules. For other markets, the dynamics can be more complicated. Mobile money providers in Pakistan are connected to the 1Link switch for interoperable transactions, but rule-setting is managed by 1Link, which is owned by the banks.
Some of the most effective schemes have proven to be where participants have a say in setting the rules. In markets where top-down mandates have been pursued instead, an intransigence on the part of providers is not uncommon. Imagine a rental agreement in which regulators decided where you were going to live and what fee the landlord was going to earn. Viewed in those terms, it is small wonder that some of these top-down plans have not ended well.
Operations, economics and technology
Once membership and participation are established (i.e., it is clear whose voices will be heard and how loudly), rule-setting is less controversial. Every institution has a vested interest in making sure fraud is collectively managed and customers are adequately identified, that basic security precautions are taken and anti-money laundering measures are in place and that processes exist for activities like dispute resolution.
On these substantive issues, the two most contentious topics are typically the business rules and clearing/settlement arrangements. The business rules define how the economic interests of participants, who are also typically competitors, will be balanced. Will some form of interchange be paid on each transaction between participants? What, if any, switching fee will be charged? Clearing and settlement rules define the processes and technology that will be used to actually complete the transactions. Will participants route transactions through a central switch, an aggregator or directly through application programming interfaces? How often will transactions be settled and where?
Interesting post. A point missing is: how members will interact with non-members. In many countries, a central bank operated RTGS is most basic form system to transfer funds among banks. When it is replicated to create a bank-led model of payments system (such as NPCI in India), innovative service providers (fintech and non-banks) miss out. Incumbents act as gatekeepers to access payment systems and enhance cost of entry and operation. Models are slowly emerging to allow interoperability between members and non-members. However, such models mostly limit to technical interoperability and do not go full scale.
Absolutely; there is a whole separate question of how those without a say in rule setting are allowed to use these rails (or not). For examples like the Pakistan one mentioned in the post, non-banks may be able to use the service, just without voting rights in scheme governance. For a market like India, the experience of non-banks has been largely limited to working through a bank partner. The ideal scenario from CGAP’s perspective is inclusive governance, where each participant has a seat at the table. However, a number of factors impact whether that actually happens in a given market (e.g., regulation, financial position, strategy and positioning of incumbent FS providers, etc.). - Will