ITLAWYERS - ΗΛΕΚΤΡΟΝΙΚΟ ΧΡΗΜΑ   (Thesis)                              

The Legislative Framework on the Use of Electronic Money

 

CONTENTS

 

Chapter One

1.      Scope

 

Chapter Two

Part A

1.      Definitions of E-money

2.      Technological Characteristics

3.      Advantages and Disadvantages of Use

Part B

1.      The United Kingdom Regulatory Regime

2.      Is an E-money Issuer a Bank?

3.      Who can Issue E-money?

4.      The Financial Services Regulations

5.      Conclusion

 

Chapter Three

Security of Electronic Payments

1.      Encryption

2.      Trusted Third Parties (TTP’s)

3.      Digital Signatures

4.      Regulatory Issues

5.      Security of E-money- Concluding Remarks

 

Chapter Four

1.      E-money Institutions (EMI)

2.      Consumer Protection

3.      Interoperability

 

Chapter Five

1.      Observations on the Use of E-money

2.      Potential for Growth

3.      Consumer Confidence

4.      Next Steps

 

 

 

Chapter One

 

1. Scope

       The scope of this work is to throw light on the various aspects of the use of electronic money and the legal implications that emerge from their introduction in the United Kingdom. This project does not purport to provide an exhaustive code on this subject. Such an attempt would be over ambitious and probably unsuccessful. It is not a simple task to attempt to demonstrate the legal implications of all payment mechanisms that exist in the sphere of electronic commerce. Rather, it sought to include alternative means of payment over the Internet, other than those traditionally used, and to examine their legal implications.

       The advent of on-line sales requires reliable forms of remote payment systems in order to facilitate transactions over the Internet. Two main approaches have been recognized to be able to meet this demand. Firstly, the accommodation and adaptation of existing payment methods; for example those systems that use debit / credit cards. Secondly, digital cash systems or e-money solutions, which have been specifically designed for digital transfer of funds over the Internet or other electronic means of communication.

       This second method of payment and the legal issues governing its use falls within the scope of this work.

       A payment system can only function successfully when it operates within a well-laid legal regime. It can only function properly if there are clear procedures for the various transactions and designed rights and obligations for the parties involved. The reliability element of electronic money encompasses security, accuracy, fast access, widespread acceptance and confidence in using this medium of payment. Therefore, for any payment system to be successful these minimum standards must be met. Some of them rely upon technological innovations and market strategies while others on the efficiency of the regulatory framework either on a national or international level.

       The structure of a particular legal system and the broader system of governance of which it forms part, plays a major role on how a payment system will operate on a day-to-day basis and in the long term. A payment system that has a strong statutory basis will depend upon rules and regulations previously set up in detail having the force of law, and will benefit in its operation. Furthermore, as new methods of Internet payment are developed, the legal framework needs to be flexible enough so that it could be adjusted and improved accordingly to fit the new circumstances.

       This work reviews the development of electronic money, the UK and the European position toward them, as well as the risks and implications that are hidden behind its issuance and use. Although electronic money creates opportunities for efficiency gains in retail payments, it is important that its development should not jeopardize either the smooth functioning of other payment systems or the stability of the financial system as a whole. The existing legal framework that governs the use of E-cash is far from clear. Existing pieces of legislation were not designed to regulate the various aspects of e-money, and therefore make their development impractical.

Nevertheless, the commercial use of the Internet is expanding rapidly. Driven by the weaknesses of traditional payment systems, modern trends of commerce point to the eventual rise of electronic payments. E-cash undoubtedly forms part of the new payment system. Whilst, electronic payments (and in our case E-money) might not completely replace traditional systems, there is certainly plenty of room for growth and will eventually form a major part of our every day transactions. By examining the existing legal system and pointing the weak points that restrain the use of E-money, it is possible to understand and overcome the difficulties that arise.

       To be effective, a legal regime must be drafted according to the policies adopted by governments and should reflect the needs and advances of the society at the time. When undertaking the task to examine the legal framework, one should always bare in mind the implications that arise from its interpretation and whether it embodies the real intentions of the regulators. Moreover, the continuous change of social norms and expectations often renders some laws obsolete and dictates either their modification to meet the new demands or, where the changes are deeper, their abolition and introduction of new ones.

Based on these grounds, it feels more appropriate to examine the legal framework that governs the issue and use of electronic money in relation to current commercial practices and economic trends of modern times. Hence, a considerable part of this work focuses on the economic developments surrounding the use of electronic money and will attempt to examine them in relation to the monetary policy and the challenges they inflict on the legal structure of the financial system.

 

 

Chapter Two

 

Part A

1. Definition(s) of Electronic money

         In theory, digital cash is an electronic equal to ‘real’ cash. Therefore, they have ‘face’ value since, as with cash, transfer of value takes place simultaneously with the transaction, not on a ‘pay later’ basis. There are two main types of digital cash systems: smart cards and software programs stored on the user’s PC. This chapter examines their main characteristics, and their main advantages and disadvantages that follow their use. 

E-money is a payment instrument whereby monetary value is electronically stored on a technical device in the possession of the customer. The amount of stored value is increased or decreased according to the transactions made by the customer. The ECB ‘Report on Electronic Money’ gives the following definition of electronic money: "electronic money is broadly defined as an electronic store of monetary value on a technical device that may be widely used for making payments to undertakings other than the issuer without necessarily involving bank accounts in the transaction, but acting as a prepaid bearer instrument."

A recent legal definition of electronic money is provided by Article 1 of the European Parliament and Council Directive 2000/46/EC. According to this definition, “electronic money shall mean monetary value as represented by a claim on the issuer which is: i) stored on an electronic device; ii) issued on receipt of funds of an amount not less in value than the monetary value issued, iii) accepted as means of payment by undertakings other than the issuer. iv) generated for the purpose of effecting electronic transfers of limited value payments.”

The two definitions recognize that electronic money refers to products widely used for making payments to undertakings other than the issuer. They introduce the concept of multipurpose and limited purpose payment instruments. The EC Directive 2000/46/EC goes on further to introduce the concept of a claim on the electronic money issuer. Such an inclusion establishes the financial responsibility of the issuer towards the holder of the money.

 

2. Technological characteristics

On the technological level there are two main distinctions: the software based and the hardware based electronic money. The distinction derives from the way the value is stored. Therefore, when value is stored in specialized software they fall within the former category while those whose value is stored in computerized chips, featuring hardware based security characteristics, fall within the latter. There are several variations to each category. Some of them have already reach their final shape while others are still developing. Money transfers with cards are most often made through card readers (or writers), while transfers using computers or wireless devices are made over wired or wireless communication networks such as the Internet without the need of additional hardware.

Nevertheless, there are many objections with regard to the qualification of smart cards as electronic cash. It is argued that a smart card is simply an electronic warehouse for existing cash deposits. Mondex for example is such a smart card. It is a plastic card with an embedded microchip, which was designed principally to facilitate ‘micropayments’. It represents a form of ‘virtual cash’ and is programmed to reflect an amount of money prepaid to the Mondex issuer by the cardholder. On the other hand electronic cash such as Digicash and Cybercash are software programs which facilitate the creation of electronic value tokens which are digitally recorded on computers. It seems therefore that the main differences exist mainly on the technological level. The Commission’s Explanatory memorandum makes it clear that for the purposes of the EU Directive 2000/46/EC both smart cards and e-cash qualify as electronic money:  “electronic money can best be conceived as a digital form of cash since it has many of the characteristics of cash. The primary similarity is that to use electronic money, authorisation is not required from a bank or other third party. Customers buy the electronic equivalent of coins and notes i.e. they exchange cash, on a one for one basis, for monetary value. The customer, in effect, has exchanged cash for another means of payment. This monetary value is stored either on a "chip" card, for example on a card similar to a phone-card, or in the form of computer software, which can be stored on the customer's PC and can be used to buy both "virtual" products over the Internet (such as music, books, computer programmes etc.) or "real" products which will be delivered to the customer's home or place of work. Chip cards generally replace small amounts of cash and are used mainly for small purchases.”

It seems therefore, that both smart cards and software money fall within the definition of electronic money, nevertheless, representing different technological innovations. However from a technological point of view smart cards cannot qualify as electronic cash because they feature different technical characteristics.

In either case it is worth looking upon the advantages and disadvantages of their use as a whole.

 

3. Advantages and Disadvantages of use

The emergence of electronic money is seen as the electronic equivalent of cash. It inherits therefore almost all the advantages and disadvantages of physical cash. However, some of its unique features introduce fresh capabilities to the electronic payment systems.

First, e-money makes micropayments attractive. One of the benefits that electronic money has over cash and other payment instruments is the ability to make very small electronic payments, such as Ό or ½ of 1 EURO cent. Second, e-money can be used by everybody who wishes to make electronic payments without the need to maintain a bank account as with credit or debit cards. Third, they reduce the chances of fraudulent or unauthorised used up to a certain extend, since at present their use is mainly for small amounts rendering their appeal not attractive to criminals. Furthermore, several schemes of electronic money use encryption and other security and authorization features to tackle unauthorised use. Fourthly, they reduce the cost of several types of transactions. For banknotes and coins, as well as for cheques, handling costs are sizeable. For credit and debit cards, the main costs arise from bookkeeping in relation to bank accounts, including the verification and transfer processes necessary to relocate funds between accounts. With electronic money on the other hand, many transaction costs are reduced. The merchant is no longer required to handle banknotes and coins for change, nor has to spend money on the physical maintenance and security of vending machines and other devices.

In addition to these advantages over existing payment mechanisms there is also the potential for growth of electronic money because of its generic characteristics which effect and settle commercial transactions almost instantaneously. This is accomplished by overlapping the need for an intermediary.

Furthermore, it is an ideal medium for anonymous transactions because value transfer is instantaneous. This feature is extremely popular with individuals who want to keep their identity confidential.

As with any new concept, electronic money faces a number of obstacles rendering its future growth vague. The main difficulties that occur from their use are largely user based. Nevertheless, there are also some technical difficulties that contribute to the complexity of their use and which need to be resolved so that electronic money can become more user friendly. In addition, many concerns have been raised over the reliability of the network infrastructure on to which the whole payment mechanism is based. Network breakdowns, although more rare as technology advances, pose serious threat to their integrity. What then if the computer crashes or the connection goes down? It seems that an on-line payment system will always be affected by the risks of system failure. Moreover, the cost of going or staying on-line to complete a transaction is a deterrent to using electronic money, not considering the fact that many users have little or no access to electronic means in the first place. However, as with any other new technology, users are proven to accept changes (and inconveniencies) relatively painless when there is substantial potential for gain or resourceful use.

 Is it possible to stop payments? Instantaneous transfers may from one point of view be advantageous but when it comes to stopping or reversing payments this can also be disadvantageous too. What about money laundering? Anonymity can serve the interests of users well but also gives the opportunity for illegal activities since the authorities find it difficult to track down illegal transactions when the records of the identities of the parties involved are not kept. Nevertheless, such problems exist with almost any other payment mechanism whether electronic or not.

Finally, the most important aspect of the use of electronic money is the establishment and maintenance of an effective regulatory framework, and its compliance with the existing monetary policy.

When considering the use of electronic money it is imperative that users can feel relaxed to use this medium of payment. It is not enough that there are numerous opportunities for retail gains. The need for consumer protection is equally important. This entails stricter rules and regulations to protect the public. However, widespread availability and easy access is the forefront for growth and success of e-money. To ensure these preconditions regulators have to provide a stable and effective regulatory framework without compromising on issues such as consumer protection and public policy. It is not enough that electronic money can provide an alternative payment method when access is limited to few users in a small geographical area, and the regulatory framework that governs the issuance and use is in primitive condition and unclear.

 

 

Part B

1. The United Kingdom Regulatory Regime

       Having identified the main issues raised from the introduction of electronic money it is imperative to access the regulatory framework currently in operation. This can be done by examining the provisions found in various statutes and other regulatory instruments. Although the vast range and diversity of payment systems would appear to inhibit classification of e-money, there are certain features which can be identified as common in to some or all of these systems.

 

2. Is an e-money issuer a Bank?

       An important point to determine is whether or not the issuer of e-money requires authorization as a credit institution. In the UK the Bank of England will carry out a supervisory function over the institutions which accept deposits. The main matter is therefore whether or not the issue of electronic money falls within the definition of the term ‘deposit taking’. According to the Banking Act 1987 if a person or institution accepts deposits in the course of carrying on a deposit-taking business then they will require authorization from the Bank of England. Section 5(1) of the Banking Act 1987 defines a deposit as a sum of money which is paid to an institution on the understanding that:

a)        it will be repaid ,and,

b)        it  was not paid in return for the provision of property or services or as a security.

Section 6(1) of the Act defines a ‘deposit taking business as one that:

a)        lends the deposits received to others, or

b)        finances other business out of the capital or interest received by deposits.

Therefore, whether or not a system requires authorization by the Bank of England dependents on how the system actually works. Some electronic money schemes work by manipulating the user’s bank account or by holding funds which are then delivered to the seller on authorization or notice from the buyer. In such a case the actions of the e-money institution do not amount to deposit taking since the money are not repaid to the original lodger of the funds. The Nicholson Graham & Jones Report suggests that such schemes act as an intermediary who issues the funds to someone else rather than a ‘deposit taking’ institution.

Other schemes work by way of providing a service and the money they receive are valuated as consideration for the services they provide. The mere taking of a deposit does not fall within the scope of the banking regulation. It is the repayable amount that would bring the activities of such schemes within the definition. Issuers who fall within the definition would then be defined as credit or banking institutions and need to obtain authorization according to the provisions of the Second Banking Co-Ordination Directive. The requirement of authorization is created to give the Bank of England supervisory role over banks and to ensure that they maintain adequate funds to meet their risks and liabilities.

The Banking Code states that an electronic purse should be treated in the same way as cash in a wallet therefore if it is lost or stolen the value would be lost just as the cash in a wallet would be forfeited. The Banking Code, although being a voluntary code is followed by all banks in the United Kingdom. Many of its provisions follow closely the 1997 Commission Recommendations on electronic payment instruments. The provisions of the recommendation provide added security to the holder of electronic money when the issuing institution is a bank. They cover cases of theft or loss of the electronic payment instrument and the exact liabilities of the issuer in cases of non-execution or defective execution of the customer’s transactions. In that sense it is preferable to have e-money issued by a bank by way of deposit taking because it will ensure greater security for the user. 

 

3. Who can issue e-money?

       Equally important in determining the ability to issue e-money by institutions other than banks are the provisions of the Bank Charter Act 1844, which sets up restrictions on who can issue private bank notes. Section 11 of the Act states that ‘it shall not be lawful for any banker to… issue any bill of exchange or promissory note or engagement for the payment of money to bearer on demand…’ Therefore, for e-money to constitute private bank notes they must either be a bill of exchange or a promissory note. Sections 3(1) and 83(1) of the Bills of Exchange Act 1882 define these two terms as ‘an unconditional order/promise in writing addressed by one person to another signed by the person giving it, requiring the person to whom it is addressed to pay on demand a sum certain in money…’

       The Bills of Exchange Act 1882 does not provide us with the definitions of the words writing and signed. Nevertheless, in the Interpretation Act 1978 sch.1 ‘writing’ is stated to include ‘other modes of reproducing words in a visible form’. Furthermore, the Electronic Communications Act 2000 makes clear that electronic signatures are intended to have the same legal effect as written signatures, provided that signatures are verified by an accredited certificated service provider. Having said so, it seems that the intention of the parliament, when the Bank Charter Act 1884, and the Bills of Exchange Act 1882 passed, was to qualify the Bank of England as the only issuer of bank notes. Moreover, at the time without the technological advances of today, and with the need to address a particular problem; namely the issuance of legal tender by private banks, those Acts passed to ensure compliance with policy.

However, today, the emergence of electronic money has proved to generate various loopholes to the provisions of these Acts, and has left the legal framework for the regulation of electronic money in an unclear state. In the light of these developments it is apparent that the government has to decide how current legislation should be interpreted. Furthermore, it is only wise to suggest that such action must take place as soon as possible to guarantee the efficient operation of the financial system and ensure that the United Kingdom is a competitive forum attractive to e-money schemes.

 

4. The Financial Services Regulations

       There is an ongoing debate over whether Financial Services Regulations apply to electronic money. The Financial Services Act 1986 prohibits anyone from conducting ‘investment business’ unless authorized to do so. The breach of such regulation constitutes a criminal offence. These provisions apply to UK and overseas companies who provide financial services to persons within the UK. The question that needs to be answered is whether e-money fall within the definition of ‘investment’. Investment advertisements by foreign companies which, are issued in the UK fall within the above definition and have to be approved by someone authorized under the Act who will take subsequent responsibility for the material.

The Financial Services Authority has stated that it is their ‘view that, for the purposes of the Act, an advertisement which can be accessed on a computer screen by a person in the UK, will have been issued in the UK’. Nevertheless, there is still the requirement that advertisements from outside the United Kingdom must be ‘directed at’ or made ‘available’ to people within other than by way of a periodical publication published and circulating principally outside the UK. 

Trystan Tether argues that the most relevant class of investment is that of debentures “including debenture stock, loan stock, bonds, certificates of deposit and other instruments creating or acknowledging indebtness”. In addition he argues that ‘electronic value’ does indeed constitute an “instrument acknowledging indebtness”, noting the definition of instrument as “any record whether or not in a form of a document”. Again the difficulties that arise from such an assumption are great. Firstly, the businesses that accept electronic money would be deemed to conduct ‘investment business’ under paragraph 12 in Part II of Schedule 1, and therefore obliged to seek FSA Authorization, which is completely impractical to require for every singe transaction that would be performed. Secondly, Paragraph 13 of Schedule 1 creates a class of investment business encompassing the arrangement of deals in investments. This would also require any person arranging such deals, where e-money payment is involved, to seek authorization from the FSA. And thirdly, there is a possibility that issues of electronic money by the value originator may require compliance with the Public Offers of Securities Regulations 1995.

 

5. Conclusion

       Having examined the most important aspects of the existing regulatory framework for the issue and use of electronic money some general conclusions can be drawn. Firstly, there is no specific set of regulations which deals directly with the implications that arise from the emergence of electronic money. Most of the existing regulations are inadequate or their use introduces more ambiguity than the one attempting to solve. This is self evident only by considering the fact that they were not designed to deal with the various aspects of the use of electronic money. Secondly, there is a need for regulation of electronic money as a matter of policy, to ensure control over the activities of e-money issuers and to uphold consumer protection.

       Suggestions have been made for minimum intervention. The reason for this approach is that since the Bank of England had up until now played practically no role in the development of payment mechanisms in the electronic age, it is unrealistic to deny to the private sector involvement in the matter at such a late stage. On the contrary, it is equally important to consider that the Bank of England has always been the sole entity responsible for issuing bank notes and therefore it is in the interests of economic and political stability to continue to do so.

       Developments on a European level seem to have gone a step further. The Commission proposal for a Directive to regulate the issuance of e-money by non banks and attempts to fit it into the existing financial services regulations have gained the European Parliament approval. The results of the Commission involvement for the regulation of non-bank e-money issuers can be found in the Directive 1000/46EC, which will be discussed thoroughly in Chapter Four of this work.  

ECB Report on Electronic Money, August 1998.

European Parliament and Council Directive 2000/46/EC on the taking up, pursuit of and prudential supervision of the business of electronic money institutions.

Michael Peirce (2001) and the EPSO database for e-payment systems maintain a list with existing e-payment systems; currently there are about 150 different schemes.

www.Mondex.com

www.digicash.com (although now out of business), and www.cybercash.com respectively.

“Explanatory Memorandum” Commission Proposal for the European Parliament and Council Directive.

Discussed in Chapters four and five respectively.

Interoperability is discussed in detail in Chapter Four, Part B.  

Banking Act 1987 s.6(1).

Nicholson Graham & Jones Report to the European Commission (DG XV) on the Legal and Regulatory Aspects of the Issue and Use of Pre-Paid Cards.

See for example Cybercash.

Second Banking Co-Ordination Directive 89/646/EEC, 1989 OJL 386/1 as amended.

Covered by the Bank Of England Act 1998.

It doesn’t seem to apply to issuers of prepaid cards.

Treatment of material on overseas WWW Sites accessible in the UK but not intended for investors in the UK, Financial Services Authority Guidance 2/98.

“Electronic Cash- The Regulatory Issues”, Trystan Tether (1997) 5 JIBFL 202.

ibid.

 

 

Chapter Three

 

Security of Electronic Payments

            The emergence of electronic money has given rise to certain issues of security. Computer networks are essential to the transmission of information involving e-money transactions. Due to the need for public access, computer networks are particularly vulnerable to unauthorized access rendering therefore transmission of financial data attractive to interception and manipulation. The science of cryptography, which is the science of keeping digital data secure, makes it possible to transmit information over electronic networks, such as the internet, relatively safe.

            The most important aspects of e-money security are: a) the authenticity of the payment message, b) the integrity of the transmitted information, and c) the private element; i.e. the extent to which privacy can be enjoyed and the extend to which public authorities have access to private communications to prevent illegal activities.

            This chapter describes the mechanisms responsible for maintaining security of communications and describes the regulatory framework in use.

            E-commerce depends heavily on transactions carried electronically. If people cannot depend on the confidentiality and authenticity of electronic information, they may revert to more traditional methods of communication and effective business transactions. In such scenario the full potential of electronic commerce may never be exploited and the revolutionary opportunity for global information society may be missed. Against this backdrop, new cryptographic techniques have been developed to facilitate and improve the communication of information through electronic means. Cryptography makes use of two important applications: digital signatures and encryption.

 

1. Encryption

            Encryption is the application to data of particular mathematical computations that are intended to have the effect of rendering that data meaningless for all other parties other than the intended recipient(s). Encryption can be used in the sphere of e-commerce to:

a)    ensure secure communication sessions (by using for example ‘SSL’s’);

b)    to encrypt specific communications;

c)    to enable digital signatures.

There are various encryption methods currently on use in the market. Most of them use different levels of encryption according to the needs of the users. Although, it is out of the scope of this work to go into a detailed description of all different techniques of encryption, key information will be provided where it is necessary to understand how the system works.

With simple key encryption whereby the sender of the codified message and the receiver use the same key for encryption and decryption, the disadvantage lies with the need to send the key to the receiver without being intercepted. This difficulty was overcome by the use of ‘public key encryption’, which revolutionized the encryption process. The essence of this process is the use of two keys. One being the public which is used by the sender to encrypt the message, and the other one, the private key to decrypt the message. A user just publishes his public key so everybody who wants to send a message to him can encrypt the message, and keeps the private key safe for his own use to decrypt messages send to him. Implementations of public key cryptography depend on calculations with very large numbers, which render interception useless unless the intercepting party holds the private key itself.

 

2. Trusted Third Parties (TTPs)

            However, even the application of strong encryption techniques such as PGP cannot completely solve the problem of securing transmission of electronic payments. How does one of the correspondents know whether he has the right key for the other correspondent, and how can he obtain it without being the subject of interception? This can be achieved by the use of Trusted Third Parties. TTP can be a centralized intermediary where both parties can entrust their public keys. So by obtaining the public key of the correspondent you wish to contact from the TTP you can be sure of the identity of the party you are corresponding with.

            At the moment there is no regulation as to who or what can be a Trusted Third Party. Nevertheless, the United Kingdom government has committed itself to introduce a voluntary system to authorize the establishment and integrity of TTPs. The argument put forward for adopting a voluntary scheme rather than a statute based one is by establishing a policy differentiation between encryption and digital signatures. 

            The DTI Consultation Paper places considerable emphasis upon the role of TTPs, despite the fact that use of them will apparently not be mandatory. In the DTI’s view, use of such intermediaries is crucial to the initial growth of e-commerce, as they are seen as providing essential guarantees of security and authenticity, two of the key ingredients to creating a climate of confidence for e-commerce and e-payment schemes.

 

3. Digital Signatures

            Signatures are crucial element to commercial transactions. English law recognize them as a way of accepting a transaction etc, and verification of the identity of the author of the document. In Goodman v. J Eban Ltd the general principle was expressed as such: “The essential requirement of signing is the affixing, either by writing with a pen or pencil or by otherwise impressing on the document, one’s name or ‘signature’ so as personally to authenticate the document”.

Electronic signatures are said be the equivalent of signatures in a digital form. The EU Directive on a Community Framework for Electronic Signatures adopts a detailed definition of electronic signatures. Article 2(1) provides the following definition:

“electronic signature means data in electronic form which are attached to or logically associated with other electronic data and which serve as a method of authentication. Advanced electronic signature means an electronic signature which meets the following requirements:

1.  it is uniquely linked to the signatory;

2.  it is capable of identifying the signatory;

3. it is created using means that the signatory can maintain under his sole control; and

4. it is linked to the data to which it relates in such a manner that any subsequent change of the data is detectable.

Electronic signatures are indeed the essential element needed in an electronic payment system to provide the minimum acceptable degree of security to encourage the widespread use of that system. It can be used to authenticate and validate e-money tokens in a unique and secure way. Additionally, it can be used to identify the identity of the parties in a transaction. When a user is be able to verify the validity and identity of the other party in a transaction, he feels more secure to engage into transactions with them. For the authentication/ verification of digital signatures two different methods may be used: 1) authentication by the recipient party directly; or 2) authentication by TTPs

 

4. Regulatory issues.

The use of e-money cannot be seen in isolation from what it purports to serve: e-commerce. For e-money to operate properly there is a whole set of different functions that need to be set into place to facilitate its use. E-money is on the one hand a medium to enable electronic payments on the other hand its’ use generates some difficulties that need to be addressed too. Whether someone chooses the use of e-money to conclude transactions, which cannot be otherwise served, or because he chooses to upgrade from other means of payment, the system he purports to adopt must be reliable and effective. Encryption and Digital signatures are the technical elements that allow, among others, e-money to function securely and to high standards. An encryption and digital signatures infrastructure provides secure authentication on the Internet and therefore its role is crucial to the evolution of e-money payments. It can help build public trust and confidence to a payment mechanism, a precondition for e-commerce success. Furthermore, reduces the potential for fraud, ensures privacy and provides merchants with the assurance of non-repudiation of a payment. In particular lack of trust to the medium of payment reduces the chances for commercial exploitation of the product itself, and in the longer term a failing e-money system may as well slow down the future growth of e-commerce. Therefore, additional emphasis must be placed to those mechanisms, which are responsible for the security aspect of the transaction.  An unregulated regime where encryption and digital signatures can be used freely with no sense of inspection and regulation whatsoever, may endanger the very purpose they intended to serve; namely the security of the commercial transactions.

In the United Kingdom two legal regimes seem to have undertaken the exclusive role of regulating them. The Electronic Communications Act 2000 and the EU Electronic Signatures Directive. The Electronic Communications Act 2000 implements the EU Electronic Signatures Directive.

Section 1 of the Act makes arrangements for the Secretary of State obliging him to establish and maintain a register of approved providers of cryptography support services. And, under section 2(4) the Secretary of State has a duty to make regulations about the requirements for approval.

Section 6 gives the definition of cryptography support service: “any service which is provided to senders and recipients of electronic communications, or to those storing electronic data, and is designed to facilitate the use of cryptographic techniques”.

Section 7 of the Act makes it clear that all types of electronic signatures, whether facilitated by approved providers or not, and irrespective of the jurisdiction where they were issued, will be legally admissible in court. As far as digital signatures is concerned, the existing provisions of the Electronic Communications Act 2000 are in line with the position adopted by the Commission in the provisions of the Directive on the matter, and no actions need to be taken to amend them to give the same effect.

Furthermore, section 8 of the Act, takes active steps to allow Ministers to have powers to pass secondary legislation to facilitate the use of electronic signatures and remove any legal obstacles that prevent their use, whenever it seems necessary.

The main elements of the Directive in regard to digital signatures as described by the Commission are the following:

·         Legal recognition: the Directive stipulates that an electronic signature cannot be legally discriminated against solely on the grounds that it is in electronic form. If a certificate and the service provider as well as the signature product used meet a set of specific requirements, there will be an automatic assumption that any resulting electronic signatures are as legally valid as a hand-written signature. Moreover, they can be used as evidence in legal proceedings.

·         Free circulation: all products and services related to electronic signatures can circulate freely and are only subject to the legislation and control by the country of origin. Member States cannot make the provision of services related to electronic signatures subject to mandatory licensing.

·         Liability: the legislation establishes minimum liability rules for service providers who would, in particular, be liable for the validity of a certificate's content. This approach ensures the free movement of certificates and certification services within the Internal Market, builds consumer trust and stimulates operators to develop secure systems and signatures without restrictive and inflexible regulation.

·         A technology-neutral framework: given the pace of technological innovation the legislation provides for legal recognition of electronic signatures irrespective of the technology used (e.g. digital signatures using asymmetric cryptography or biometrics.)

·         Scope: the legislation covers the supply of certificates to the public aimed at identifying the sender of an electronic message. In accordance with the principles of party autonomy and contractual freedom it does, however, permit the operation of schemes governed by private law agreements such as corporate Intranets or banking systems, where a relation of trust already exists and there is no obvious need for regulation.

·         International dimension: so as to promote a global market in electronic commerce the legislation includes mechanisms for co-operation with third countries on the basis of mutual recognition of certificates and on bilateral and multilateral agreements.

 

5. Security for the use of E-money- concluding remarks

            With various payment schemes penetrating the market of electronic payments, it gets increasingly difficult to access and discuss the various security methods in use. Most payment solutions rely on credit cards or a bank account, which require users to pre-register for the services. This is inconvenient and hard to manage especially when users demand anonymity on top of security. Furthermore, with most payment solutions, security protection and management are expensive to maintain and often prove unreliable. Even where they prove satisfactory the cost is so high, that it has to pass to the user to be commercial viable for the provider. This renders a system unattractive for financial reasons. However, the development of e-money (either in the form of e-cash or smart card) can overcome such difficulties quite easily with the use of encryption and digital signatures. Therefore, with the implementation of the new regulations (Electronic Communications Act 2000) an e-purse can, at very low cost provide security, anonymity, standardization and accessibility. In conjunction with the advantages already discussed earlier it proves to be quite attractive for widespread consumer and business use.

            Internet integration gives the e-purse a public key infrastructure capability, which is the backbone of traditional Internet security. With these implementations e-money cannot only hold monetary value, but also digital certificates, which can be issued by a Certification Authority within the associated network.

            Discussions about e-money security however, should not conclude at this point. They form part of a much more wider debate about the security of information in the electronic age. Recent technological advances enabled stronger encryption standards making it almost impossible for anybody to penetrate into encrypted information. As with every other technological innovation, it has both advantages and disadvantages. The primary argument favouring strong encryption and security of e-money transactions is that it tends to satisfy user protection needs and raise consumer confidence. However, this is not always the case. Strong security also leaves the door open for the unscrupulous players, uninterested in the long-term survival of the e-commerce market, to make a quick profit through cheating, fraud or other kinds of malpractice, by using in effect that same technique, which was designed to discourage them to do so in the first place. Adequate technical and organizational safeguards should be maintained to prevent threats to the security of e-money schemes. Similarly, protection against criminal abuse should be taken into account in the design and implementation of e-money schemes. Over-regulation on the one hand stifles innovation and distorts competition, on the other protects users and inspires confidence.

Faced with these challenges the regulatory framework needs to be flexible enough to allow state authorities to be able to intervene when there are signs of foul play. The Electronic Communications Act 2000 security provisions should be examined in the context of the E-commerce Directive and the Regulation of Investigatory Powers Act 2000.

Despite public outcry and the criticism by privacy advocates and libertarians, this new Act, known as the Regulation of Investigatory Powers Act 2000, has already passed through the House of Commons and the House of Lords, and received the Royal Assent. Essentially it replicates Part III of the ‘draft’ Electronic Communications Act in providing law enforcement agencies the power to require disclosure of encryption keys. Again it places the burden of proof for failing to comply with this decryption warrant upon the accused party and re-introduces the 'tipping off' offence for third parties. The Act also establishes a new £25 million Government Technical Assistance Centre (GTAC), which MI5 will use to monitor Internet traffic and e-mail communications.

Section 49 requires disclosure of encryption keys to ‘protected information’. Having obtained a warrant by the Secretary of State, the police and other law enforcement agencies, as well as any other public authority, will be able to require disclosure of an encryption key by giving a notice, which can be served to anyone believed to be in possession of the key.

Section 49 (3) provides that: “A disclosure requirement in respect of any protected information is necessary on grounds falling within this subsection if it is necessary: a)   in the interests of national security;

     b) for the purpose of preventing or detecting crime; or

     c)  in the interests of the economic well-being of the United Kingdom.”

It is unfortunate that the authorities can insist on receiving the encryption key on such wide grounds. Consequently, this provision may hurt user confidence in cryptography, and deter them from using it all, making it far more difficult to provide security to e-money transactions without using encryption techniques. The LSE’s Report estimates that the UK could loose £35 billion in e-commerce revenues to overseas jurisdictions due to the encryption key disclosure requirement alone.

            Section 53 puts the burden of proof on the defendant. All the prosecution has to prove is the possession of the key to serve the section 49 notice and the onus immediately shifts to the putative key holder that he did not have access to the encryption key.

            Section 54 introduces the offence of ‘tipping off’. Under this section anyone who was given a notice or has become aware of one is obliged to ‘keep secret the giving of the notice, its contents and things done in pursuance of it.’

            The above provisions are widely argued to be in breach of the European Convention of the Human Rights. Section 49 seems to contravene article 8 of the Convention whereas the right to private life and correspondence must be respected. Furthermore, the reversal of proof established by Section 53 is said to contravene Article 6 of the Convention for a fair trial.

            Whether the legality of the RIP 2000 Act will be established or not, it seems certain that it will hurt the development of e-money and generally that of the e-commerce. Encryption is the backbone of e-money security. Consumers will use e-money if they feel it is safe mechanism to cover their transactional needs. But a system without effective security measures is deemed to failure because it would not gain public acceptance. 

             The electronic commerce Directive which has to be implemented by 17 January 2002:

· Policy Area I: to adapt present rules and regulations, notably to bring about convergence in consumer and investor protection rules for both contractual and non-contractual obligations;

· Policy Area II: to develop measures to provide secure payment systems and out-of-court redress on a cross-border basis;

· Policy Area III: to achieve enhanced supervisory cooperation that can meet the new cross border challenges.

         

The explanatory notes (5) of the Electronic Communications Act 2000 refers to cryptography as “the science of codes and ciphers…it has long been applied by banks and government and is an essential tool for electronic commerce…[it] can be used as the basis of electronic signature”.

Secure Socket Layer (SSL) was developed by Netscape Communications and RSA Data Security and is used to form a secure information connection between a web browser and a web server.

W Diffie and M E Hellman first published this new encryption process in 1976 in the paper: “New Directions in Cryptography”, IEEE Transactions on Information Theory, IT-22: 664-654, (1976).

Further description of public key encryption can be found in the DTI Consultation Document “Building Confidence in Electronic Commerce”, DTI, 1999, URN 99/642.

Stands for Pretty Good Privacy.

UK Department of Trade and Industry Consultation Paper “Building Confidence in Electronic Commerce”, March 1999.

(1954) 1 ALL ER 763.

EU Directive on a Community Framework for Electronic Signatures 1999/93/EC.

Public consultation papers will be produced by the UK government in November and December 2001 covering the following issues: 1) Digital Signatures for Citizens, and 2) Digital Signatures for Businesses.

See for example Verisign at: [www.verisign.com].

Came into force on 25 May 2000.

Undertaken by projects such as the Open Trading Protocol, Open Buying On the Internet, and Europe’s Smart Access project.

The provisions of the data protection legislation are outside the scope of this work.

Directive 2000/31/EC of the European Parliament and of the Council of 8 June 2000 on certain legal aspects of information society services, in particular electronic commerce, in the Internal Market ('Directive on electronic commerce'), Official Journal L 178 , 17/07/2000 p. 0001 – 0016.

See also Khan v. United Kingdom (Application No 35394/97).

 

 

Chapter Four

 

1. The Electronic money Institutions (EMI)

       When examining the legal implications of the use of electronic money, it is essential that we look into those institutions that are responsible for their issue and ‘circulation’ needs, and how they are supervised by the responsible authorities. Although electronic money create opportunities for efficiency gains in retail payments, it is important that their development and use does not jeopardise either the smooth functioning of other payment schemes nor the stability of the financial system and monetary policy.

       The definition given in chapter two is the most recent legal definition adopted by the European Union and will form the basis of the United Kingdom legislation once the EU Directive on the taking up, pursuit of and prudential supervision of the business of electronic money institutions is implemented.

E-commerce is at the heart of the World Wide Web, the world's fastest growing marketplace. Estimates of the British Department for Trade and Industry (DTI) predict that e-commerce transactions in the UK are expected to be worth over £30 billion by 2002. The potential for growth of e-money seems to have been recognized by most, if not all, governments worldwide. The latest developments on the regulation of e-money on a European level favour a different legal regime for banks and for non-banks. Before looking into the provisions for the regulation of e-money issuers it is worth understanding the reason for adopting different legal regimes for bank and non-bank issuers.

The Commission’s approach is based on the principles of monetary policy that are followed until now: “European banking legislation always acknowledged that there are differences between institutions. For such targeted regulation reflecting peculiarities of certain institutions it is of course important that it does not undermine the level playing field. The suggested supervisory regime is certainly less cumbersome than that applying to banks.”  Furthermore, it states that: “The business activities and investment capabilities of electronic money institutions are substantially different from those applying to banks. […] By using this approach the Commission aims to promote competition in the evolving E-money market.” Therefore, Article 2 of the Directive provides that the First and Second Banking Directives shall not apply to EMI (except otherwise stated).

The motivation of the Commission to foster competition and innovation was met with criticism from the European Central Bank, which demanded stricter rules to apply. A compromise has been found and what is left now is the translation of the provisions of the Directive into national law.

The objective of the Directive is to provide a ‘single passport’ for issuing e-money for credit and ‘E-money institutions’. This allows electronic money institutions to issue e-money or establish branches in other Member States on the sole basis of the authorization delivered by the home Member State authorities (Article 9). Such precondition indirectly implies that third countries schemes cannot issue e-money in the European market remotely, since for a scheme to operate a grant of authorization by a Member State’s authorities is needed.

Article 4(1) provides that: “Electronic money institutions shall have an initial capital, as defined in Article 34(2), subparagraphs (1) and (2) of Directive 2000/12/EC, of not less than EUR 1 million. Notwithstanding paragraphs 2 and 3, their own funds, as defined in Directive 2000/12/EC, shall not fall below that amount.”

Article 8(1) provides: “Member States may allow their competent authorities to waive the application of some or all of the provisions of this Directive and the application of Directive 2000/12/EC to electronic money institutions in cases where either:
(a) the total business activities of the type referred to in Article 1(3)(a) of this Directive of the institution generate a total amount of financial liabilities related to outstanding electronic money that normally does not exceed EUR 5 million and never exceeds EUR 6 million,                          

or
(b) the electronic money issued by the institution is accepted as a means of payment only by any subsidiaries of the institution which perform operational or other ancillary functions related to electronic money issued or distributed by the institution, any parent undertaking of the institution or any other subsidiaries of that parent undertaking;

or
(c) electronic money issued by the institution is accepted as payment only by a limited number of undertakings, which can be clearly distinguished by: 

(i)        their location in the same premises or other limited local area;

or
(ii) their close financial or business relationship with the issuing institution, such as a common marketing or distribution scheme.

The underlying contractual arrangements must provide that the electronic storage device at the disposal of bearers for the purpose of making payments is subject to a maximum storage of not more than EUR 150.” 

       Nevertheless, the genesis of the E-money Directive has given rise to certain concerns. There are some undesired legal implications, which derive from the wording of the Directive. Firstly, with regard to the inclusion of the prohibition to the electronic money institutions to issue e-money on receipt of funds of an amount not less in value than the monetary value issued, it is thought that such prohibition should not have been included in the definition. Instead, it should have been included in a substantive article. Mark Vereecken argues that: “As a result, any E-money scheme where monetary value is being created and which has, as a consequence, an impact on monetary policy, is not captured by the definition of ‘E-money’. It is thus excluded from the scope of the Directive and is not subject to the prudential and consumer protection measures set out therein”. If the inclusion was placed in a substantive article it would have been unlikely to cause such a negative effect because it would have still been able to maintain the intend of the monetary policy i.e. to prohibit the E-money issuers from expanding the monetary mass creating price instability.

       Secondly, the Directive gives the power to the national legislators to modify some of the provisions when implementing the Directive. Regarding the issue of inflammatory E-money, the national regulators may adopt a broader definition, thus failing the intention of the Directive for harmonization. It seems that the burden for minimum harmonization falls to the co-operation and co-ordination of the national implementers of the Directive. Nevertheless, one of the main objectives of the Commission, the recognition of E-money schemes other than credit institutions, has been achieved. Additionally, it fulfils its’ objective for prudential supervision of every E-money issuer.

       Finally, it is argued that the Directive will not attract new comers in the field. The reason being that the European Central Bank in an attempt to adopt a more regulative position has ‘forced’ the Commission, which traditionally adopts a more liberal position, to stricken the regulations for issuers of electronic money. This can be seen in the differences between the draft Directive (1998) and the final version (2000). For example the requirement on initial capital was raised from EUR 500.000 to EUR 1 million. Furthermore, the waiver in the first draft could be granted at EUR 10 million outstanding e-money, while in the final draft at EUR 6 million. This indicates a turn in policy making the barrier for entrance in the market for non-banks half-open and a lot more unattractive. However, it is left to be see how the market will respond to the changes and whether telecommunication companies, retailers, ISP, and other players still be interested to enter the market. 

 

2. Consumer Protection

       An obvious question that derives from the introduction of the EMI Directive is whether the public interest is protected. As far as the objectives of the Directive are concerned, the Commission decided to include in the Directive provisions for consumer protection and confidence to the bearer of E-money.

       The prudential framework set up by the Directive aims at safeguarding the financial integrity and stability of E-money institutions. This ensures the consumer that the issuer is a sound institution properly supervised and able to meet its financial liabilities at all times. Furthermore, there are restrictions placed in the activities and investments of e-money issuers to compensate for the lighter prudential supervision placed on them in relation to credit institutions. This ensures that the e-money institutions by having low-risk investment policy would have a sound operation and financial stability and thus boost consumer confidence in accepting money issued by them.

       The requirement of redeemability ensures the consumer the benefit of the right to exchange his e-money back into coins and banknotes at the same value they were issued. Therefore, users have the security that any e-money they hold will not devalue making it easy for them even to accept e-money payments as part of their transactions.  

       Electronic money is being considered by some as the main future challenge to central banking. There will always be a need for the element of security, confidence and information that central bank money have. Unregulated electronic money cannot provide such a fundamental precondition. The attitude of the European Central Bank in the implementation of the Directive proves its’ concerns on this level. In order to ensure that the central bank does not loose its ability to preserve price stability and to maintain the unit of account function of money a certain degree of regulation is indispensable. The inclusion of the provisions for ‘prudential supervision’ and ‘restrictive granting’ in the Directive advocates the position of the European Central Bank for a clear regulatory framework whereas issuers are adequately supervised.

      

 3. Interoperability  

       The recent move toward the standardization of payment mechanisms is presented mainly as being of vital importance for cross-border transactions and global commerce. Surprisingly, until recently, little attention was paid to the importance of e-money interoperability for e-commerce over the Internet. On the one hand, the Internet is accessible globally, enabling businesses to advertise and sell on-line, and as Tweed put it: “The nature of the Internet means that consumers from many geographical regions could be interested in products or services, which are for sale. It is important for merchants to maximize their potential market by allowing as many consumers as possible to buy their products”. On the other hand consumers’ willingness to pay increases due to cheaper services and products available on the Internet. Nevertheless, the lack of widely accepted e-payment system is considered to be a barrier to the taking up of e-money payments.

       Therefore, it is thought that a development of a wide accepted system will be the single factor for consumer acceptance. Thus, it may be that any system, whether formally standardized and secured or not, could gain market dominance and remain in that position by virtue of its being the ad hoc standard. This is not entirely true. Other barriers to a wider adoption of on-line payment schemes include consumer reluctance and cultural difference. Furthermore, up to a certain extend cross-border interoperability of e-money follows the line of common technology implemented in different countries.

       Baring this in mind it is imperative to examine whether interoperability within the European Union is the single factor for enabling e-money payment schemes to take off, and whether there is any progress toward achieving this end.

       Despite the adoption of various e-payment schemes in most countries, the overall acceptability of e-money is hampered by the multiplicity of solutions that do not interoperate with each other. In 1999 the Common Electronic Purse Specification (CEPS) was launched with a target to interoperate e-purse transactions. In conjunction with the European Committee for Banking Standards (ECBS), key organizations in electronic payment systems have already combined powers to define elements of a common functional specification that will enable migration to interoperable schemes.

       K. Böhle in “The Potential of Server-based Internet Payment Systems, An attempt to assess the future of Internet payments” raises the question whether cross-border interoperable systems are of any practical use at present. He states that: “It is an open question: could these payment service providers co-operate internationally and thus ease cross border payments? One may also ask what potential internationally operating payment service providers (like SmartAxis or Bibit) have for increasing the chances of more efficient cross-border payments of different types soon?” In the light of such remarks the ECBS notes that there are other solutions for interoperability besides agreeing on a common standard (for example letting the consumer use more than one schemes).

       Nevertheless, the answer may be hidden in the idiosyncratic character of the Internet. The argument in favour of interoperability goes like this: “Given that the Internet is a global market, the prevalent situation with several incompatible national schemes would most likely have proven to be equally as detrimental for the adoption of electronic purses as an Internet payment system, as local rivalry may be in the case of their adoption as a domestic real-world payment system. Or as Poynder recently phrased it: "Until and unless a globally accepted purse architecture appears, or the main e-purse products are modified to be interoperable, then this situation will do much to prevent the successful international proliferation of e-commerce, especially when it relates to low value information".” Hence, incompatible systems reduce the size of the potential market. The result being failure to reach a critical mass of customers, which is essential for the financial viability of the scheme. Consumers and retailers are concerned about the prospect of growth of a payment scheme, and if they feel that the scheme does not have the potential to grow beyond a specific area or point they are reluctant to join especially when the costs for switching scheme are high. 

       The introduction of the Euro in 2002 will undoubtedly have an overall positive effect on cross border e-commerce. A common currency will open the door for interoperable e-money to operate more efficiently because it will eliminate foreign exchange risks and reduce high commission fees.

       Moreover, experts point out that cross-border trade of intangible products (which are traded almost exclusively through the internet) might develop more rapidly if it is stimulated by interoperable electronic payment systems such as e-money.

       On the other hand there is a strong argument, which suggests that interoperability of e-money systems on a local/national level may be a more appropriate strategic decision at present, given the low frequency of transactions using e-money. The logic behind this proposition is the need for e-money schemes first to establish themselves and then seek expansion and co-operation among them for the services they are offering. It is argued that the best move will be to have competition within national borders so that the best schemes from each country would establish themselves, and later when the industry matures will seek to establish a common infrastructure and compete in the single market. However, such proposition does not take in account the other players that are also competing to take a share of the market. The longer it takes to implement an interoperable European infrastructure for e-money payments, the greater the advantage for the credit card institutions (for example Visa) to take charge of the market is going to be.

       In that respect it seems that the Electronic Money Directive has achieved its objectives by providing at least as a starting point a level playing field. The recognition of this new type of financial institutions, namely the e-money institutions, provides the legal basis for establishing and operating e-money schemes.

The success of such schemes therefore does not lie within the regulatory framework, which, despite its alleged defects, is more or less already established. It rather depends on market dynamics and strategic decisions of the e-money institutions involved. And what a better strategy than creating interoperable e-money schemes offering services, which would enhance Internet payment solutions across borders and satisfy consumers’ and retailers’ appetites for cash alike electronic transactions.

       It seems that standardization is the obvious way to achieve interoperability. However, attempts to regulate interoperability of e-money schemes by enforcing standardization would entail enormous risks and possible refusal by the majority of the institutions. In a report by ePSO the authors agreeing that interoperability of e-payments has not yet been achieved, argue that many e-money schemes have established their own customs and do not wish to make large changes because this would upset their customers; merchants and consumers. Furthermore, they argue that there are other paths to interoperability, other than standardization, and that: “Interoperability is not just a question of cards, card readers and the respective software. Interoperability also requires business agreements and a common clearing settlement system. Such a system may also require co-operation between banks and non-banks and cross-border co-operation”. It looks therefore extremely unlikely that such a great number of institutions from entirely different and often contradicting industries would ever agree to co-operate on such a complex issue especially when success is not guaranteed. Even a mandatory regulatory framework, which would impose standardization as a mean of achieving interoperability, might cause more distortion to the development of an interoperable system of payments than the one trying to resolve. It is not surprising the fact that EMI Directive does not deal with the issue at all. Anyway, the objective of the Directive is to achieve a common legal framework to encourage competition and consumer choice with minimum intervention and harmonization. It is out of its scope to solve the technical difficulties that emerge from the introduction of electronic money. The Commission thought that it was better left to technological innovations and market dynamics to solve such matters.

Pan-European standards and protocols on both technological and strategic related issues need to emerge through consensus-building and market-driven processes. However, for this development to take place smoothly, and in a way that does not exacerbate security concerns and create a confusion of conflicting solutions, a systematic information exchange at a European level is needed. In this regard, the ITPS has created an activity- ePSO, aiming at establishing a European reference point of excellence that will develop a continuous monitoring and analysis function focused on emerging developments in issues related to e-payment systems, with a view to leading to consensus-building. This will be achieved by setting up and running a Forum of experts and market players, addressing technological and strategic issues in e-payment systems. Other institutes of the Joint Research Centre are also involved in this field.

To round off, it must be kept in mind that e-money payments and e-money institutions in particular are still in their early days of growth, and that excessive market intervention and over-regulation might altogether prove way out of line. Certainly the best approach at the current level, having established a basic legal framework and competition policy, is to adopt a close monitoring policy, and let the market evolve making interventions only where necessary.

Referring to non-bank institutions.

Official Journal L 275 , 27/10/2000. Article 10: Member States shall bring into force the laws, regulations and administrative provisions necessary to comply with this Directive not later than 27 April 2002.

Extract from the: “Explanatory Memorandum, Commission proposal for European Parliament and Council Directives on the taking up, the pursuit and the prudential supervision of the business of electronic money institutions.”

Ibid.

Codified Banking Directive 2000/28/EC which amends the 2000/12/EC Directive.

The articles by Marc Vereecken “A Harmonised EU Legal Framework for E-money”, Simon Lelieveldt “Why is the E-money Directive Significant”, and Hugo Godschalk “Genesis of the EU Directive on E-money Institutions”, show that the draft Directive was changed substantially under the influence of the European Central Bank.

"Payment System Rules in the European Union: A critical analysis of the EU Payment System Recommendations, the Cross-border credit transfer Directive, the Settlement Finality Directive and the E-money Directives", Van Empel, M., Banking and EC Law Commentary, Amsterdam Financial Series, Kluwer, Chapter 16.

This section does not deal with private international law matters.

(1998).

Weiler, RM “Money transactions, and trade on the internet”, thesis Imperial College London, 1995.

Background Paper No 3, Electronic Payment Systems Observatory (ePSO), Draft for revision by the ePSO Steering Group, March 2001.

R. Poynder, 1998. "Today's technology: Understanding e-money and e-commerce," E-Money, volume 1, number 3 (July), p. 1821.

Extract from Leo Van Hoven’s “E-purses, Interoperability and the Internet”, Leo Van Hoven, First Monday, vol. 4, issue 4, 1999.

K. Böhle, M. Krueger, C Herrmann, G Carat, I Maghiros, Background Paper No 1, “Electronic Payment Systems, Strategic and Technical issues”, ePSO, December 2000.

Institute for Prospective Technological Studies, Directorate General Joint Research Centre, European Commission.

See the JRC website at: [www.jrc.es].

 

 

Chapter Five

 

1. Observations on the use of electronic money

Pending implementation of the European Union Directive on E-money institutions by national legislation, it seems that the legislative framework governing the issuance and use of electronic money, will undergo radical changes to comply with the requirements set therein. At the same time, there are many concerns raised about the potential of e-money as a method of electronic payment. Many observers argue that e-money schemes would probably fail simply because other, well established, schemes like credit cards, debit cards, electronic fund transfers etc. are also competing in as much the same market but at much more favourite terms, having gained so far public approval. This would be irresponsible not to take into account. Again, the European Central Bank and most of the Member States’ central banks seem reluctant to accept, or willing to give away powers for issuing e-money to private institutions, especially when they cannot supervise them under the powers given to them by the Banking Directives. This was clearly seen in the draft of the EMI Directive, where the European Central Bank put pressure on the Commission to adopt a more restrictive regime for e-money institutions.

       Furthermore, there is an on-going debate about the level of consumer protection and consumer confidence that can be achieved by the current legislation in regard to the use of e-money for on-line payments.

       With so many obstacles put forward and a number of failures already reported for e-money schemes, being only in the first years of their operation, one may find it difficult to accept future success for e-money institutions.

This is however, only one side of the story. In the following paragraphs of this chapter we will attempt to demonstrate that a case for growth exists. Moreover, it will be shown that consumer protection would not be scrutinized by the development of e-money schemes, and that the adoption of a clear and straight legal framework will help into building up consumer confidence.

 

2. Potential for growth

       It is mentioned above that e-money schemes would not stand a chance for growth in an environment dominated by colossal market players such as credit card institutions and banks. However, given the evolution of e-commerce into a major marketplace, it is unrealistic to suggest that only a limited type of transactions occur or will occur. As with ‘physical’ commerce, different payment mechanisms operate to cover different types of transactions. The major idea behind the emergence of e-money was to replace cash for transactions taking place in the virtual world. Being the payment mechanism that shares the most common characteristics with cash, its use is supposed to cover transactions similar to those for which the medium for payment is cash. In that respect, one could argue that e-money schemes are not in fact competing against other methods of payment for market dominance since the portion of payments, which would otherwise be served by cash could now be served by e-cash. H. Godschalk and M. Krueger note in their paper that “The main reasons for non-banks to issue prepaid cards were cash substitution, customer loyalty and discount programs”. E-money have strong potential for growth if they can establish a Unique Selling Position. They argue that: “Until now the issuers of e-money copied traditional cash as medium of exchange with 100% liquidity and acceptance. Therefore, it competes with all established payment schemes in the marketplace. Maybe this is the wrong strategy. The unique point of e-money is programmability […] the market indicates that success of e-money will depend on using this USP.”

       The reaction of the central banks to e-money is driven merely by the threat they are posing to the monopolistic position they hold and merely because of the fear that an unregulated regime would signal the rebirth of private currencies and free banking. It is not exaggerating to predict that an unregulated environment would (as explained in the previous chapters) create inflammatory pressures and pose threat to monetary policy. This position, reflected in the 1994 EMI-report on prepaid cards, where it was stated that only credit institutions should be allowed to issue e-purses, is clearly reversed in the legal regime established by the EMI-Directive 1000/46, where the notion of e-money institutions is introduced to allow non-bank institutions, to issue e-money.

       The significance of the EMI-Directive can be determined on two levels. Firstly, its various provisions (discussed in Chapter Four), establish a legal framework, which regulates and supervises the issuance of e-money by private institutions; and secondly, reinforces the position of the Commission to support alternative methods of e-payments and encourage competition between institutions to provide financial services: “The Directive sends out the signal that an organization does not have to be a fully fledged credit institution to be active in this market. Credit institutions may take this as a warning and may assume similar regulatory approaches in the future. They can no longer assume that the supervisory entry barrier will remain as high as it has been in the past.”

    As far as micro-payments is concerned, the dominant payment mechanism is determined by its ability to handle frequent and accurate payments at low cost. E-money uniqueness fills the gap of such transactional needs, while it opens the door for a whole new range of services where micro-payment is the only possible way to make efficient payments. Therefore, the adoption of e-money as a payment mechanism does not only facilitate the needs of existing commercial uses, it also enables businesses and commercial entities to introduce and exploitate new services to the market. Take for example payments for intangible products. First of all, payments for intangible products are rare today. Although the Internet is ideally suited for the delivery of software and digital documents of all kinds, there is no adequate payment mechanism for them, which will facilitate micro-transactions. There is also no adequate payment mechanism for Small businesses and private persons, who occasionally would like to offer goods on the Internet, but are not willing to accept credit cards. E-money as they are understood today could provide an efficient solution to solve some or all aspects of the problem.

     In regard to the harmonization of e-money payments within the European Union, the difficulty is due to the political developments rather than technological integration. When talking about the Euro, EMU and electronic payments systems, it important to consider that a whole range of expectations goes along with European Integration. People using e-money expect to use them everywhere across Europe. The political task to undergo radical changes and meet these expectations is considerably more difficult than the necessary sort-term economic and technological changes. However, such awareness on the part of the European Commission is visible in that it has already provided for a regulatory infrastructure to address the various issues and that it actively promotes a singe financial market. In addition, most observers agree that in the sphere of electronic payments mechanisms, most systems will co-exist, therefore the objective should be a standardization of the payment infrastructure and a distinction between standard payment infrastructure and product standards. Failure to follow this line of strategy would probably eliminate competition between products and service providers. 

 

3. Consumer Confidence

       Probably the most important aspect for the development of e-money is consumer confidence. With regard to e-money the title ‘consumer’ can be said to include both merchants and private persons. Consequently, this would help understand that the confidence element is equally important to both categories of users, and measures taken must be directed at both to reach the desired results. It is not good enough to have merchants on the one side willing to accept e-money payments when, on the other, private persons are reluctant to do so.

       The Commission in a recent communication to the European parliament places great importance on consumer confidence for the development of e-money schemes. It clarifies that a new policy framework will be developed, to encourage consumer confidence in cross-border redress and Internet payments. The initiative provides that: “A Community-wide network of financial services complaints bodies will be established to provide effective and rapid out of court redress on a cross-border basis. Steps will be taken to improve security and provide consumers with legislative safety when making payments on-line within the Union.”

       Talking consumer confidence, security issues are of fundamental importance. The E-money Directive (2000/46EC) provides that electronic money may be issued only by supervised institutions meeting certain legal and financial conditions, ensuring technical security. However, some concerns are raised over the effectiveness of some of the security provisions. In its own findings the Commission admits that: “The present legislative framework provides consumers with some protection but it does not meet many of the concerns associated with on-line trade within the Community”, and reserves to propose a series of measures (study of security features of new payment solutions for e-commerce, exchange of information, training, and provision of educational material) to deter fraudsters and raise consumer confidence.

      A legislative ‘safety net’ must combine of measures:

a)    for the criminalization of fraud and counterfeiting;

b)    for reassurance that a refund will be made if problems occur; and

c)    for active involvement of e-money institutions in a payment malfunction or dispute.

It is thought that the third category of measures can be achieved by non-legislative measures, if it gains the backing of the institutions involved. Moreover, the Commission proposes that: “the Industry also needs to be involved in resolving disputes between the consumer and the merchant about the non-delivery (but not quality) of the product or service for which the consumer has already paid. The burdens on those involved in the payment process also need to be kept to a minimum. Systems that enable merchants in one Member State to verify the identity of consumers in another are essential if abuse of a refund system is to be minimized.”

 

4. Next Steps

       The next step in the regulation of e-money has to progress rapidly. This becomes necessary in an environment where e-commerce is developing fast. Regulatory authorities need to react fast to market developments. National legislation must implement European initiatives within tight set deadlines to ensure compliance. On the other hand the European legislative bodies have to revise existing measures and strategies constantly to remove obstacles in the development of the market.

       National requirements must be addressed by conducting national experts to gather information, while extensive consultations need to be held to identify where further harmonization might be necessary and to review national rules protecting consumers in transactions to determine how retail financial services can be freely offered throughout the Community in a framework of legal certainty, delivering increased choice and lower prices.

See for example Digicash, which filed for voluntary bankruptcy in 1999.

“Why e-money still fails”, Paper prepared for the Third Berlin Internet Economics Workshop, Berlin 2000.

Discussed in detail by Dorn (1997) and Krueger (1999).

Lelleveldt, S. “Why is the Electronic Money Directive Significant” at: [http:// epso.jrs.es/newsletter/vol07/5.html].

see [http://Europa.eu.int/comm./dg15/en/finances/general/action.htm].

Communication from the Commission to the Council and the European Parliament: E-commerce and Financial services, July 2001.

Ibid at p16.

Ibid at p17.

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