THE ESTONIAN MINISTRY OF FINANCE, THE BANK OF ESTONIA AND THE ESTONIAN FINANCIAL SUPERVISION AUTHORITY

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1 EUROPEAN COMMISSION INTERNAL MARKET AND SERVICES DG B-1049 BRUSSEL BELGIUM OCTOBER 18th, 2005 THE RESPONSE BY THE ESTONIAN MINISTRY OF FINANCE, THE BANK OF ESTONIA AND THE ESTONIAN FINANCIAL SUPERVISION AUTHORITY TO THE QUESTIONNAIRE ON THE ELECTRONIC MONEY DIRECTIVE (2000/46/EC) INTRODUCTION Since the 1990s, after the invention of electronic money e-money, there have been predictions of explosive use of this new means of payment. In spite of being in theory an excellent means of payment, in reality e-money still represents a very small fraction from the total amount of money in the European Union (EU). Currently, there are no clear-cut card-based and network-/software-based e-money schemes in Estonia (EE) established under the E-Money Directive (the Directive). However, the payment environment in Estonia is mainly electronic and the number of less efficient payment channels, such as bank offices has decreased continuously. As regards electronic payment channels, largest growth has occurred in the number of subscribers of the Internet banking service. Also, one new technologically advanced payment method mobile phone payments for goods and services has become more and more popular lately. With reference to the questionnaire on the Directive firstly we give our general comments on that issue. Comments on the Directive In our opinion, the Directive is proven to be rather over-regulative and aims basically to regulate one specific and narrow means of payment. Therefore one could say that the Directive has somewhat failed to achieve one of its objectives of starting up the e-money issuing business mainly because it has turned out to be too burdensome. In addition, the E-Money Directive is not adapted to the market conditions in many cases and thus has to some extent hampered technological development and possible innovation of e-money. We agree with the opinion of presence of conflict between the need to ensure stability and soundness vs. encouraging new market entrants and assisting the development of e-money. Ministry of Finance Suur-Ameerika Tallinn Estonia Phone: Fax: info@fin.ee Bank of Estonia Estonia Bld Tallinn Estonia Phone: Fax: info@epbe.ee Financial Supervision Authority Sakala Tallinn Estonia Phone: Fax: info@fi.ee

2 Proposals Firstly, we propose to expressis verbis distinguish between the deposit taking activity and the issuance of e-money. It is necessary to set apart the issuance of electronic money and a deposit-taking activity. That is, e-money should be considered as an electronic surrogate for coins and banknotes and not a deposit taking thus, there is in principle no need to apply deposit guarantee scheme on e-money schemes. We also find that prohibiting interest being paid on funds received in exchange for electronic money will differentiate credit institutions and deposit taking from e-money institutions or similar undertakings (the so-called hybrid institutions ). Secondly, there is no crystal clear answer if at all and what kind of EU legislation (ELMI Directive, New Legal Framework for payments in the internal market or etc) should cover the pre-paid products offered by the so-called hybrid institutions, where e-money services are a non-core part of their business (e.g. mobile operators). Definitely the extra requirements to these institutions are costly and can bring along huge expenses to the whole industry. On the other hand, unfair competition situation caused by the regulatory arbitrage, which favors for example the mobile firms, can damage the e- money industry. However, in general we are of the opinion that the hybrid institutions (e.g. mobile operators) should not be classified as E-Money Institutions (ELMIs) under the scope of the Directive. For example, one possible solution would be applying to the hybrid institutions the similar or the same requirements as to the other payment service providers under the new proposal of the NLF. Another option to distinguish hybrid institutions from ELMIs would be setting up a threshold for electronic money s float outstanding (or the threshold of financial liabilities related to outstanding electronic money) that will establish the level for intervention based on risk. In conclusion, there is obviously no need to introduce a special EU regime for institutions issuing e- money as a non-core part of their business. However, there is still a need to re-assess the original goals of the Directive. 1. Questions: a) Has a level playing-field between ELMIs and other credit institutions issuing E-Money been achieved? b) Has a level playing-field between ELMIs and other pre-paid payment service providers issuing E- Money been achieved? c) Has the Directive encouraged competition? If so, is competition between institutions issuing E- Money fair? d) Has the Directive encouraged new market entrants? (EE): Estonia has a little practical experience with ELMIs as we do not have any of these institutions established under the Directive so far and the Directive has not been harmonized into the Estonian legislation yet (the Act of e-money institutions will probably be adopted by the Estonian Parliament by the end of 2005). In our opinion, as the number of established ELMIs is relatively small in the EU it refers that the current legal construction of Electronic Money Institution is somewhat questionable. Also, the current EU legal framework of ELMIs does not make it very attractive for non-banks to become an ELMI and the definition of e-money is open to interpretation. 2. Questions: a) Have the harmonised provisions of the E-Money Directive eliminated legal uncertainty in the field of E-Money? 2

3 b) Does the directive establish the conditions necessary to ensure that any kind of E-Money issuance takes place within a clear legal framework? c) Does the Directive establish market confidence in, and public awareness of, E-Money? EE: Despite the fact that we have very little practical experience we believe that the Directive has succeeded in eliminating some legal uncertainty in the field of e-money. Also, please see the general comments above. 3. Questions: a) Has the regulatory prudential framework achieved its objective of ensuring stability and soundness of issuers? b) Has the regulatory prudential framework increased business and consumer confidence in E- Money products? EE: In Estonia, so far there have not been established any ELMIs, neither does any credit institution issue e-money. However, we find that a feasible prudential framework for ELMIs is a substantive element enhancing overall financial stability. It is also necessary to increase the business and consumer confidence of e-money products. Nevertheless, the levels of prudential requirements may need further elaboration to find appropriate balance especially between financial soundness of ELMI-s and consumer confidence. 4. Questions: a) Has the regulatory framework of the E-Money Directive assisted the development of E-Money in the context of electronic commerce and avoided hampering technological development? b) Has the Directive encouraged technological innovation? EE: The Directive leaves the issue of some elements of the services provided by mobile operators somewhat uncertain. Also, please see the general comments above. 5. Questions: a) Has the E-Money Directive facilitated access by ELMIs from one Member State to another? b) To what extent has the E-Money Directive facilitated integration of E-Money Market across the EEA? EE: Two credit institutions from the United Kingdom have notified the Estonian Financial Supervision Authority of their intention to provide in Estonia cross-border services strictly limited to the issuance of e-money. However, reference in the notifications was made to the Directive 2000/12/EC. In our opinion the integration of E-Money market mainly depends on the interoperability of the e-money schemes. The interoperability in turn depends on integrated standards and unified technological platforms. Currently there are many different e-money schemes operational in the EEA and they are not interoperable, which prevents their wider cross-border use. 6. Questions: a) Has the regulatory framework of the E-Money Directive enabled the development of E-Money unimpaired by strict technological rules? b) To what extent has the regulation of E-Money succeeded in its original aim of remaining technologically neutral? EE: The Directive has remained technologically neutral and the technological aspects were left to the hands of businesses. 3

4 7. Questions: a) Do you agree that the original goals of the E-Money are those which the Commission has identified above? b) Is there a risk that the goals as set out above conflict with one another (e.g. the need to ensure stability and soundness vs. encouraging new market entrants and assisting the development of E-Money)? c) Is there a need to re-assess the original goals and to perhaps establish new goals? If so, what should these be? d) Should e.g. establishing consistency with the New Legal Framework for Payments be considered as a new goal? EE: We agree that the original goals of the Directive were those, which were identified above. Indeed, there is always a risk that the goals as set out above conflict with one another. Also, we find that establishing consistency with the New Legal Framework for Payments should be considered as one of the objectives in reviewing the ELMIs Directive. To find the appropriate balance between ensuring stability on one side and encouraging new market entrants on the other side remains a huge challenge especially to the Commission and the Member States but also to the market players themselves. As the e-commerce (including e-money) sector is one of the fastest growing industries in the world, the primary objectives need definitely reassessing although the Directive has been in force for a relatively short time. 8. Questions: a) Has the Directive created an appropriate legal background to protect E-Money bearers? b) Have there been cases of consumer detriment caused by the lack of adequate measures to protect E-Money bearers? c) Is there a need for additional measures aimed at the protection of bearers of electronic money? d) Do you think that E-Money should be covered by a guarantee scheme? e) If so, how should it be funded? EE: In principle, we are of the opinion that the Directive has created an appropriate legal background to protect e-money bearers. Nevertheless, as the measures aimed to protect the bearers of electronic money have significant importance, any extra means should be evidence-based and will have to yield significant economic benefits to both sides to businesses and customers. Otherwise, this can bring along the increase of administrative costs, which may culminate with a price boost to retail customers. As the size of average ELMI operating in the Single Market is relatively small compared to deposit taking institutions banks, then there is obviously no need to place the ELMIs under the protection of guarantee schemes. However, if the scale of their activities will grow domestically and also in the cross-border sense in the future, which in turn may contain notable risks to financial stability, that question might be considered again. 9. Questions: a) Is there a need to review provisions on initial capital and ongoing own funds requirements? b) Are the requirements of the Directive proportionate to risks E-Money institutions are exposed to? EE: Yes, there is a need to review provisions on initial capital and ongoing own funds requirements and these requirements must be proportionate to risks. 10. Questions: 4

5 a) What has been your practical experience of the application of waiver rules? b) Do the existing rules correspond to the needs and realities of E-Money business? c) Should the rules on waivers be changed, and if so in which way? d) Could the extensive and consistent application of waivers encourage E-Money issuance at national level? e) Should the threshold of financial liabilities ( 6 million) related to outstanding E-Money be amended or removed? f) Is the amount of maximum storage at the disposal of bearers for the purpose of making payments ( 150) still relevant in the case of a waiver? g) Is there a need to allow the competent authorities of Member States to waive the application of provisions of the Directive in other specific cases not provided for in the Directive? h) Should the waiver be granted automatically or should every waiver be decided by the competent authority case by case? EE: As we have so far no domestic e-money providers established in Estonia, we cannot comment on our experiences on the adequacy of the waiver rules related to the E-Money Directive. In general, however, we do not support any special treatment on the regulatory level. As described in our general comments, the existing regulatory framework in principle may not correspond to the needs and realities of the e- money business (please also see the general comments above). Therefore, we agree that waivers could be one possibility at least in the short run for encouraging the entrance to the market of the new e-money institutions operating on the national level. One option is to consider using the waiver or to waive the application of some provisions of the Directive in the case of mobile operators (if they provide e-money services). Nevertheless, the threshold of financial liabilities and the amount of maximum storage at the disposal may need a possible update. This must be based on real experience of other Member States where the ELMIs are operating widely. In cases where the rules of waiver are stipulated relatively explicitly in the legislation granting of the waivers could be done automatically, otherwise waivers should be decided by the competent authority case by case. 11. Questions: a) Are there any examples of ELMIs having offered to pay interest on E-Money or demanding the right to pay interest? b) Is there a need to prohibit interest being paid on funds received in exchange for electronic money? EE: Up to today in Estonia, there have not been any examples of ELMIs having offered to pay interest on e-money or demanding the right to pay interest. Prohibiting interest being paid on funds received in exchange for electronic money is one of the criteria of e-money and therefore we basically support that criterion to be sustained. Please also see the general comments above. 12. Questions: a) Should the definition of E-Money institution be broadened/narrowed to cover/exclude institutions issuing a prepaid means of payment for their core service but which may also issue E-Money as a non-core part of their business (e.g. mobile operators and other hybrid institutions )? b) Should a special EU regime be introduced for institutions issuing E-Money as a non-core part of their business (e.g. mobile operators and other hybrid prepaid instrument providers)? 5

6 EE: In our opinion, the definition of e-money explains its nature. We find that institutions issuing a prepaid means of payment as a non-core part of their business should not be covered by the Directive. Please also find further particulars in the general comments above. When considering a possible broadening of the definition of e-money institution, we propose to make more cautious steps. Without any further examinations, broadening the Directive could bring about negative implications to the stakeholders (e.g. mobile operators) and to the e-commerce industry on the whole. 13. Questions: a) Is the definition of E-Money appropriate and adapted to any kind of E-Money issuance? b) For the sake of clarity and to avoid any legal uncertainty, does the definition of E-Money need to be clarified? Has the definition of E-Money given rise to different interpretations, either across different business models or as a result of different Member States interpretations? c) Does the definition of E-Money correspond to the way the market has developed or is likely to develop? d) Is there a need to review the definition of E-Money? e) Do the three criteria in the definition of E-Money (stored on electronic device, issued on receipt of funds not less than monetary value issued, accepted by undertakings other than the issuer) constitute the determining elements as to what really constitutes electronic money? f) Would it be appropriate to introduce a reference to "any prepaid float/funds allocated to payment? g) Which payment instruments in your experience/country fall under the definition of E-Money? Should the definition of E-Money cover pre-paid products of mobile operators? EE: The need for clarification of the definition depends mainly on the goals of the Directive to which industry exactly and to how large extent the EU e-money legal framework is purposed to apply. However, due to the development of technologies we believe that the definition of e-money needs a further review. For example, we find that the third criteria accepted as means of payment by undertakings other than the issuer may need further clarification. It also remains uncertain whether government agencies are included under the undertakings or not. Currently a few means of payment in Estonia contain some elements of e-money. 14. Questions: a) Is the limitation of E-Money institutions activities too restrictive? b) Does the limitation of activities discourage new entrants, restrict competition or hinder innovation? c) Does the limitation of activities contribute to preserving a level playing field between ELMIs and other credit institutions or alternatively disadvantage ELMIs in comparison with other credit institutions that issue E-Money? d) Does the restriction on the granting of any form of credit have an impact on the payment possibilities offered through E-Money instruments? For example, does the delay in some payment transactions constitute credit in your experience/member State? EE: Taking into account the new developments in e-commerce industry and new business lines the limitation of ELMIs activities may be too restrictive. Also, the limitation of activities may discourage new entrants, restrict competition and hinder innovation. In Estonia, we proceed from an agreed provision that e-money cannot be issued in the form of credit. In case of some hybrid payment schemes offered by the mobile operators, the delay in payment transactions can be considered as credit, offered by the service provider. 6

7 15. Questions: a) Has the application of the passporting provisions of Directive 2000/12/EC given rise to any specific problems? b) To what extent has the single passport been used by licensed ELMIs? c) Is it still valid to define an ELMI as a credit institution under Directive 2000/12/EC (as amended) despite the fact that ELMIs are legally barred from granting credit and from paying interest on funds received in exchange for E-Money issued? EE: So far the application of the passporting provisions of Directive 2000/12/EC has not given any rise to any specific problems. Two credit institutions from the UK have notified the Estonian Financial Supervision Authority of their intention to provide in Estonia cross-border services strictly limited to the issuance of e-money. However, reference in the notification has made to the Directive 2000/12/EC. We agree that there is no need to define an ELMI as a credit institution under Directive 2000/12/EC (as amended). 16. Questions: a) Is it still valid to distinguish between the different nature of the issuance of electronic money and a deposit-taking activity in the interests of bearer confidence? b) If funds received are immediately exchanged for E-Money, at which point in time does the conversion into E-Money actually take place? c) Should the notion of deposit-taking in Article 3 of Directive 2000/12/EC be clarified? EE: It is still valid to distinguish between the different nature of the issuance of electronic money and deposit-taking activity. In our view the conversion has been completed as soon as the resources have been stored on the electronic device. However, the time gap between the receiving of the funds and funds being available for use on the device should be considered as if the conversion is still going on. Relying on the precondition that in practice there are no problems with applying the immediate conversion of e-money there is no need to clarify the notion of deposit-taking in Article 3 of Directive 2000/12/EC. 17. Questions: a) Does redeemability at par value pose any special problems for E-Money issuers? b) How could this rule be adapted to institutions issuing E-Money as a non-core part of their business (for example, mobile operators) for which the E-Money float on prepaid cards or accounts is only known ex post when customers have purchased goods and services from a third party? c) Is a minimum threshold of EUR 10 for redemption at par value still relevant? EE: Since we have not had enough experience with e-money institutions operating on our market we cannot provide any specific comments on the subject. In general, we find that the redeemability at par value, even in case e-money float on prepaid cards or accounts is only known ex post, should not pose any special problems for ELMIs. Therefore, creating extra legislative measures seems to be questionable. However, in principle, the bearer of electronic money must have a right to ask the issuer to redeem the electronic value at par value in any kind of money (cash or account money). There is basically no need to stipulate minimum threshold for redemption. The e-money issuer should only have an option to cover the actual cost of redemption in a form of a separately indicated service fee. For example, the cost of 7

8 transfer of redeemed e-money to clients accounts costs for the e-money issuer and clients should cover this cost. 18. Questions: a) Have the provisions of the Directive on limitation of investments achieved their aim of establishing a level playing field between ELMIs and credit institutions? b) Are the provisions of the Directive too restrictive for ELMIs? c) If so, have they deterred new market entrants, restricted competition or hindered innovation? EE: Please see our general comments and answers to this issue presented above. Nevertheless, comparing the capital and investment requirements of ELMIs with other financial institutions management companies, investment firms, these provisions may be too restrictive. Possible amendments of the Directive could be necessary to prevent the barriers for market entrance and the hindering of innovation. 19. Questions: a) Do national customer due diligence provisions, such as "Know Your Customer", record keeping requirements and other established principles in banking law pose specific problems to the issuance of electronic money despite the exemptions foreseen for E-Money? If so, which? b) Is it possible to sell anonymous pre-paid cards (or other electronic devices) in your country? EE: Up to now there are no anonymous prepaid card based e-money schemes operational in Estonia. But in principle, it is possible to sell anonymous pre-paid cards (or other electronic devices) in Estonia. The Draft Law on E-Money Institutions amends the Money Laundering and Terrorist Financing Prevention Act by expanding the preventive measures including CDD measures to e-money institutions as well. The customer due diligence provisions can possibly pose specific problems to the issuance of electronic money. However, without any practical experience it is troublesome to give any specific reasoning. 20. Questions: a) Would you agree that the E-Money market has either failed to develop to or not yet reached its full potential? b) If so, what are the main reasons for the limited development of the E-Money market? c) Have any particular obstacles constrained the E-Money market growth across the EEA? d) What are the prospects for the future development of E-Money? e) Is the E-Money Directive adapted to the market conditions? f) If not, are there any amendments to the Directive which are needed in order to reflect the E- Money market developments, especially as regards technological innovations? g) Are there any obstacles in the taxation area constraining the E-Money market development? h) What changes, if any, might be needed to the E-Money legal framework in the light of forthcoming Directive on Payment Services (New Legal Framework)? EE: We find that the e-money market has experienced little bit of both: it has failed to develop and not yet reached to its full potential (please also see the general comments above). In Estonia, we have not experienced any particular obstacles that might have constrained the e-money market growth across the EEA. One of the reasons for the limited development of e-money in Estonia is that in our country other electronic means of payment services are well advanced which leaves less potential for e-money providers. We find that there are several reasons for the limited development of the e-money market as a whole. One reason for the limited development of the prepaid payment instruments market is that it was somewhat overregulated at a very early stage of its introduction. In addition, lack of unified 8

9 international standards has hampered the development of interoperable schemes. The developed schemes have not had a clear business case and therefore did not achieve large operational scale. Lack of clear business case and interoperability are still the main obstacles for the development of widely used e-money in Europe. The main e-money market driving forces are: acceptance, convenience, and cost. On the whole the business case for e-money is not making profit but saving costs. Most likely the e-money function could in the future be applied to other widely used payment cards like debit or credit cards using the Low Value Payment type cheaper solution based on interoperable EMV standard. A proportionate and clear regulatory environment for e-money is crucial to the growth of the whole e- commerce industry including mobile operator services. The Directive may have to be amended or even repealed, to take account of the hybrid prepaid payment services. In principle, this can be done in a technologically neutral way. In addition, the e-money legal framework should not contradict with the forthcoming Directive on Payment Services (NLF). 9