The Regulation of Electronic Money Institutions in the SADC Region: Some Lessons from the EU

This article analyses the different approaches adopted for the regulation of payment systems in a variety of legislative instruments by the European Union (EU). It looks in particular at how the institutions that issue new electronic money products are regulated and supervised by the relevant authorities in the EU, in comparison with existing institutions such as banks. It analyses some of the lessons that may be learned by the South African Development Corporation (SADC) from the regulatory approaches for electronic money institutions adopted by the EU. The article asks if the approach adopted by the EU may be useful for the future regulation of electronic money institutions in the SADC. The proliferation of electronic devices that arrived with the invention of the Internet has sparked some regulatory challenges. This development has become global and involves both developed and developing countries, including regions such as the SADC. It is asked if these technological developments should be addressed by means of a concrete regulatory framework while they continue to develop, instead of the regulators waiting to observe and acquaint themselves with the relevant regulatory challenges that underpin the innovations. The EU has attempted to address the anticipated regulatory challenges that came about with the development of electronic money and to align its regulatory approach with other payment systems. This article discusses the regulatory approaches adopted in the EU and provides an overview that the SADC may use in order to adopt an effective regulatory framework for electronic money and the institutions that issue these methods of payment. It analyses both the achievements and the challenges that the EU faced (and continues to face) in developing the regulation of e-money, and recommends some possible approaches derived from the lessons learned.


Introduction
The dawn of the computer network and the subsequent introduction of the Internet to the general public have changed the way in which society communicates and uses information. One noticeable benefit is the impact of technology in terms of creating various opportunities for trade and commerce, which include making payments more efficient, safer and quicker. Banking via the Internet has become increasingly popular. This has become an important reason for the introduction and development of a large number of electronic payment systems. With this rapid technological development, electronic money (or "e-money") and electronic devices (such as "digital cash" or the "smart card") now make it easy and convenient to manage and transfer funds without having to carry large sums of cash. Notwithstanding the rapid developments in these payment systems, the attitude adopted by the regulatory industry for many years, as Mann 1 correctly observes, "opposed regulation fearing that regulation would stifle developing business models". The author further acknowledges a possible and necessary shift from this attitude "simply due to the level of uncertainty in the interpretation of existing law". 2 This uncertainty is evident also in the area of electronic payment systems and poses several regulatory challenges. These include, among others, whether electronic money constitutes money or legal tender, and whether or not issuers of these methods of payment are deposit-taking institutions and therefore subject to the stiff soundness and prudential regulatory frameworks applicable to banks. Furthermore, these developments raise relevant questions regarding whether or not e-money  10 The Recital specifies that the issuance of e-money does not constitute a deposit-taking activity "in view of its specific character as an electronic surrogate for coins and banknotes". The E-money Directive 2009/110/EC has adopted a "technically neutral" (also known as "technology neutral") approach for the definition of e-money in recital 7 of the E-money Directive 2009/110/EC. 11 The main purpose of this approach is to cover all situations where a payment service provider issues a pre-paid stored value in exchange for funds. 12 As discussed below, one of the characteristics of this approach is that the rule regulating technology should be flexible enough to embrace technological changes and market developments. 13 A regulating instrument is therefore not required to define or specify the relevant technology that falls under its scope. The adoption of this approach may, as discussed below, give rise to different interpretations. The question raised may be whether or not a particular technology used for a particular payment system is important to determine whether or not such payment system falls under the regulatory scope of the E-money Directive 2009/110/EC. If a strict technology neutral approach is applied, such determination may create challenges for the regulators of e-money institutions.

Different categories of electronic payment systems
The categories of electronic payment systems that can be found in the literature include electronic payment systems as either access (or account-based) products or stored-value (or token-based) products. 14 This classification is technical and therefore not a strict one. An electronic payment system may fall into one or both of these categories.
Account-based products refer to payment systems in terms of which money is represented by numbers in a conventional bank account, and these numbers are transferred between parties in an electronic manner via computer networks. 15 The underlying principle of these systems is that the instruction to exchange money between bank accounts is maintained by the institution that initiated the payment systems, such as a technology company which has an agreement with the bank to provide payment services. 16 Examples in this category are credit or debit cards, ATMs and Internet banking through which EFT facilities are provided, which essentially facilitate access to money in a bank account.
Token-based products, on the other hand, are devices that allow participants to exchange electronic tokens during the transaction, without relying on a bank account. 17 The system used to effect payment carries the value on itself in the form of a digital coin or token. 18 The equivalent value of traditional money is converted into electronic tokens and transferred into a digital account before it can be spent. 19 It is not clear, however, whether or not access products are covered by the definition adopted by the EU in the E-money Directive 2009/110/EC.
One important classification of token-based e-money products is emphasised in various definitions. E-money products are classified as hardware-based stored-value cards, and software-based electronic cash. 20 The primary difference between the two classifications is not patently clear. This classification plays a vital role in the analysis of the existing e-money market and the rationale for the regulation of e-money under the EU. The hardware-based e-money involves the use of a small plastic card with a small, round gold metal microchip embedded at the back of the card. 21

Different regulatory and institutional approaches
By way of comparison, there are two different approaches to the regulation of emoney. These approaches are summarised as the "wait-and-see approach" (or "leave it to the market approach") and the "in-advance regulatory approach". 28 A consideration of these approaches provides insight into the possibilities in regulating e-money institutions.
A wait-and-see approach is generally adopted to avoid stiff regulation which could hamper development and the introduction of new technologies. 29 The premise of this approach is not to overreact to the regulation of these technologies, but to maintain expertise in these products and their development, which is likely to occur at a rapid pace, and to allow for careful studies of potential issues. 30 The approach requires regulators to "be cautious and to at least wait for a partially proven business before burdening the business with regulation". 31 It shuns any regulatory intervention that 22 Mills The weaknesses of this approach are threefold. Firstly, the market entry of these technologies may be slow in the absence of a proper legal framework, which should be implemented to address issues such as consumer protection. Consumers who access these products in the absence of a proper legal framework may face risks such as fraud, theft, and unfair trade practices. 33 They may also have no legal remedies if they are subject to operational errors and the malfunctioning of the systems used to facilitate payments using e-money. 34 Secondly, a legal framework is crucial to guard against possible systematic risks arising from the operation of institutions that provide for these products. Thirdly (and connected to the second point), adopting a legal framework will level the playing field for existing financial institutions and new market entrants that also want to provide these payment systems.
The in-advance regulatory approach, on the other hand, has a different focus for regulating payment systems. It pre-empts the challenges of redressing undesirable situations once e-money schemes are fully introduced and widely used. 35 This approach takes into account the stability of existing payment systems under the existing financial services framework, with banks as the main providers. The approach accepts that these payment systems may be regulated under the regulatory framework relating to banks. However, it also recognises a circular academic debate regarding whether the issuing of e-money should be the function of banks or other institutions. 36 The essence of the debate is whether the value or purchasing power loaded onto these e-money devices represents, for the issuers, a source of funds equivalent to "deposit-taking", which is the main function of banks. 37 The argument is that if non-bank institutions are allowed to offer e-money services, there is a necessity to regulate these institutions in order to enhance consumer protection, facilitate the development of e-commerce, and create legal certainty. 38 Such regulation is also required to encourage new market entrants of non-bank institutions and to stimulate competition between banks and non-bank institutions in their rendering of e-money services. 39 The problem in adopting this approach is that one needs to be able to distinguish between the different entities that may issue emoney and the impact on them of the existing regulatory framework for banks. Such a distinction must take into account the involvement of separate legal entities which may serve as e-money issuers or service providers. As discussed below, 40 the EU has adopted this approach for the reasons mentioned above. The EU had either to impose on these entities the existing licensing or prudential requirements applicable to banks or to design new ones specifically for them. The key question was the extent to which these requirements should be guided by the requirements relating to the licensing of banks.
Historically, payment systems were exclusively the functions of regulated commercial banks over and above their deposit-taking functions. Banks are also market leaders in piloting e-money products. 41 However, the licensing and prudential regulation essentially targets the main function of banks as deposit-taking institutions. This seems to ignore other functions of banks as facilitators of payment systems and as e-money issuers, as well as the exclusive risks inherent in these functions. It further ignores other non-banking institutions, such as telecommunication operators and computer companies, which are attempting to enter the markets involved in the issuing of e-money products in competition with conventional banks. 42 The following description of e-money products, which focuses on the issuing entities, outlines different regulatory models that may be adopted in the regulation of e-money issuers. 38 Penn 2005 JFRC 349. 39 Krueger "E-money Regulation" 239. According to a report by the World Bank on its effort to combat money laundering facilitated through the internet (ie cyber laundering), there are predominantly four models of e-payment systems involving different avenues through which e-payments can be made. 43 These models have been utilised effectively to explain the possible regulatory and supervisory approach to e-money institutions. 44 The first model is called the merchant issuer model. 45 In terms of this model, the issuer of an electronic payment such as a stored value smart card and the retailer are the same person. 46 The merchant who sells the goods and services to whom payment is made is also the issuer of the goods or services. 47 In this case, a traditional bank is not involved in the issuing of electronic payment. The second model is a bank-issuer model, in terms of which the issuer (who is a bank) and the retailer are different parties and the transaction is cleared through the usual financial systems. The issuer may be affiliated to a bank and thus serve as an operator of payments using emoney. A model which is the direct opposite is the non-bank issuer model. 48 In terms of this model, the issuer from whom the user buys electronic value is not a bank but a technology company that has introduced the e-money product and supplies it either to banks or directly to users. 49 Traditional banks, as in the merchant-issuer model, are not involved in the process of issuing electronic payments. 50 This model is also known as the "gatekeeping strategy", in terms of which banks' involvement is limited to the role of gatekeepers to control the entrance of new e-money institutions into the financial services. 51 The final model is the peer-to-peer model. 52 In this model, a bank or non-bank may issue e-money. 53 Once issued, the e-money may be transferred between users with or without the use of a traditional banking system. 54 The essence of this approach is its provision of options to determine whether the issuer of e-money should be a bank or not. These models provide the regulators of new e-money institutions with options to decide on the model that will best suit their domestic circumstances. Whatever model is chosen, an important factor that must be taken into account is whether traditional banks must be involved only in the issuing of e-money or in both the issuing and the processing of payment.
The discussion below 55 examines a plausible model for the regulation of e-money institutions in the SADC region.

5
The regulation of e-money products in the SADC region The implementation of electronic payment systems on the African continent has made visible progress. However, e-money products in the SADC region are penetrating very slowly. 66 The primary cause of this delay is the issue of the convertibility of local currencies in most of the SADC member states, which hampers the opportunity for online cross-border trade using electronic payment systems.
According to Lawrence and Tar, "[m]ost consumer markets face severe limitations in terms of connectivity, ability to pay ... ownership of credit cards, and access to other means of payment for online purchases". 67 The insufficient availability of technological infrastructure and the inadequacy of the legal and regulatory framework are additional factors. 68 An appropriate regulatory framework is also essential for the adoption and implementation of e-money products.
The SADC is currently involved in several projects to integrate the payment systems of its member states. Its main focus at the moment is on the establishment of the has been devoted to establishing a regulatory framework for electronic commerce in general, and payment systems and issuing institutions in particular. 70 SADC is not indifferent to the integration of a legal framework for the regulation of electronic payment systems, however. It is evident that the 1992 SADC Treaty encourages member states to harmonise policies in certain areas of co-operation, including finance, science and technology, and services. 71 Some relevant discussions aimed at harmonising the supervision of banks and their regulations are also continuing. The starting point is to have some sort of harmonised regional regime for the regulation and supervision of financial services, including e-money products and the institutions that issue them. SADC should therefore focus on the full integration of banking and other financial markets as one feature of its monetary union goal. 72 Nevertheless, most SADC member states seem to have adopted a wait-and-see approach and are therefore reluctant to begin with the stiff regulation of e-money, which could hamper the introduction of these innovative and promising technologies. 73

A brief regulatory background
The EU started discussions on the regulation of electronic money in 1994. Its main concern was to address two problems, namely: the soundness of the issuers of emoney products and the soundness of e-money as a method of payment. 74 The EU demanded far-reaching steps to regulate the issuing of e-money products. Different approaches and the EU's position on the regulation of e-money were proposed to the EU Commission by the European Monetary Institute. 75 In a 1994 report 76 to the EU Commission, the European Monetary Institute proposed a regime based on the bank-issuer model for the issuing of e-money with regard to prepaid stored-value smart cards. Its suggestion for this "bank only approach" was to reserve the issuing 70 Mezghani "E-commerce Readiness in the SADC".

71
Article 21 of SADC Treaty (1992 of e-money for banks (which it refers to as "credit institutions"). 77 One simple motivation determined its position. The European Monetary Institute looked at the economic description of the term "deposit" or "deposit-taking" to decide on its position. It treated the value of the money received by the issuer as a claim which the cardholder had on the third party and which could be used to make payment to a wide range of retailers. 78 It concluded that the same reasons for authorities to reserve deposit-taking functions specifically for banks, in order to ensure the soundness of the payment system and protect consumers against systematic risks, should also apply to the issuers of e-money products. 79  and to strengthen their prudential supervision and the protection of their clients. 91 Article 4 defined a "credit institution" as "an undertaking whose main business is to receive deposits or other repayable funds from the public and [that] grants credits for its own account". The directive also imposed prudential requirements that consider the risks inherent in the business of deposit-taking. Article 8 required credit institutions to be authorised before commencing such business. It is a prerequisite for authorisation of a credit institution that it must possess an initial capital of not less than 5 million euros in terms of

Lessons learned from the EU's regulatory regime
The first lesson to be learned from the EU's legal framework is its adoption of a technology-neutral approach (or "techno-neutral"), which serves to achieve one of When the approach is applied to e-money products, it requires the products envisaged in the regulatory instrument not to favour, for instance, only hardwarebased e-money, but to include its software-based counterpart. It also requires the legislator to second-guess any other types of e-money products that may be developed with future technological innovations. The rules must be wide-ranging and inclusive of all possible products that may fall under the realm of an e-money regulatory framework. This means that the "law must encompass anything under the sun made by man". 142 The shortcoming of this approach is that the choice as to which electronic devices are subject to regulation is left open to the regulating authorities. 143 Under the E-money Directive 2000/46/EC and E-money Directive 2009/110/EC, the approach has rendered absolute neutrality a myth. As the discussion below relating to the definitions of e-money will indicate, these directives are in theory techno-neutral, but are techno-specific in practice. The anomaly of the approach is that one technology may, by definition, be preferred in the regulatory development process. As has been correctly stated, "the EU Directives often express support for technology-neutral policies, but once rhetoric translates into action, technology-specific policies are (often) implemented". 144 As a result, existing technology benchmarks and conditions the way in which the regulators think. 145 In addition, although the regulators rightly envisage techno-neutrality in order for current e-money instruments to be forward-looking, the regulatory process often 139 Reed Making Laws for Cyberspace 190-191. 140 Ali 2009 Lex Electronica 12.
fails to deliver such neutrality and causes problems of interpretation, application and definition (as well as classification) of the subject matter of regulation. The lesson to be learned from this approach is that absolute techno-neutrality may not be viable.
It is suggested that some balance between techno-neutrality and techno-specific regulation must be fostered in order to achieve the intended objectives. If a technology-neutral approach is adopted, it is advisable to have a definition of emoney that will determine the scope of the relevant regulating instrument. proportionate prudential requirements must be tested in terms of a balance between ensuring the stability of the institution and avoiding the creation of barriers to market entry and enhancing new innovations in this market. In this case, setting the initial capital amount is less important than achieving the envisaged objectives of a legal framework.

Conclusion
The proliferation of e-money and the legal and regulatory questions that it continues to ask cannot be avoided. Regulatory authorities, even in developing regions such as the SADC, cannot be indifferent to these developments and the regulatory challenges that they pose. Although a choice is available to "wait and see" how these developments unfold, it is clear that these developments are occurring at a rapid speed. The proliferation of PayPal and various mobile payment systems as worldwide payment devices bears witness to some of the challenges that await the regulating authorities in the near future. With these rapid developments, developing countries might not be able to catch up in terms of constructing an appropriate regulatory framework. Further adverse factors pertaining to the development of an effective framework may include factors such as the unavailability of resources and the lack of an integrated legal framework in some of these regions. For the SADC, in addition to achieving its single monetary goal, it is likely to face challenges in terms of determining what e-money means for this region. Moreover, the relevant choice as to who should issue e-money is expected to be first on the agenda by 2018.
From the lessons learned in the regulation of e-money institutions, SADC will first have to take into account the challenges that the EU encountered over the years in constructing a legal framework in Europe, as it attempted to allow further developments in the context of e-money without hindering innovation through strict regulation. SADC will also have to take the three-track regulatory regime and the anticipated convergence of the legal framework for payment services and electronic money into account. This will help to decide which payment systems should be regulated under each of the three regimes and to test the viability of the three-track regime. If the function of a particular payment system constitutes deposit-taking, it must fall under the supervisory regime applicable to banks. Likewise, if the payment system serves to facilitate access to money and the transfer of such money from one banking account to another without the institution depositing money into its own new account, the institution providing such a service should be regulated under a regime similar to that of the Payment Services Directive 2007/64/EC. Only institutions that provide stored-value products in terms of which conventional money is converted electronically and resides in the possession of the bearer of such devices (either on the stored-value smart card or the microchip of their computer) will be regulated under instruments such as the E-money Directive 2009/110/EC.
The challenge of making such decisions lies in the definition of what constitutes "emoney" and the determination of the applicable electronic devices. Such definition must set the scope of the relevant instrument so that it is comprehensive enough to remove any doubt as to whether or not electronic devices such as mobile phones are covered. The regime will therefore have to place emphasis on defining e-money and e-money institutions as well as on determining the appropriate prudential supervisory and licensing structures. The definition of e-money may adopt a technology-neutral approach. Nonetheless, a balance between techno-neutrality and techno-specificity will somehow have to be achieved. While the regime should acknowledge the prudential requirements applicable to banking supervisory structures, it should adopt a risk-based approach that is suitable to overcoming the risk challenges posed by e-money. Taking into account the embryonic status of emoney in the SADC region, the regime should begin with a bank-issuer model of regulation for banks issuing e-money. In the absence of a harmonised banking regulation in the SADC region, this will allow banks which are already regulated under domestic laws to issue e-money products in a joint venture with the financial system operators. Statistical data relating to the increased use of e-money in the SADC region will eventually provide a good reason to introduce a non-bank issuer model with a new prudential requirements regime, which will apply to independent e-money institutions. A flexible prudential regime must, however, be introduced for e-money institutions that issue e-money products. Such prudential requirements must take into account the minimal risks posed by these devices in comparison with the deposit-taking functions of banks. From the lessons learned under the EU regime it is possible to conclude that the strict requirements applicable to banks are not appropriate for e-money institutions.