Financial Market Supervision: Canada’s Perspective

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While some Canadian authorities have introduced similar initiatives such as regulatory sandboxes launched by securities regulators and working groups established by governments at all levels, there remains potential for more. For example, Canada lacks a clear and unified policy lead on FinTech.

Such a body could combine federal, provincial and territorial expertise to facilitate FinTech development, and improve the scope and applicability of existing initiatives. The Bureau encourages policymakers to continue to examine the experience of other jurisdictions and adopt best practices as they balance the potential risks with the competitive benefits. While regulation is needed to achieve important policy objectives, such as consumer protection and a stable financial system, regulations should be modernized to promote greater competition and innovation for Canadians.

Based on the findings of this market study, the Bureau developed 11 broad recommendations for financial sector regulatory authorities and policymakers to ensure future regulatory change creates space for innovation in this important sector of the Canadian economy. The Competition Bureau Bureau ensures that Canadian businesses and consumers prosper in a competitive and innovative marketplace. As an independent law enforcement agency, headed by the Commissioner of Competition, the Bureau is responsible for the administration and enforcement of the Competition Act , Consumer Packaging and Labelling Act except as it relates to food , Textile Labelling Act and Precious Metals Marking Act.

As part of its mandate, the Bureau participates in a wide range of activities to promote and advocate for the benefits of a competitive marketplace such as lower prices for consumers as well as increased choice and innovation. Market studies are one of the tools that the Bureau uses to advocate for competition. They allow the Bureau to assess an industry through a "competition lens" to highlight issues that may restrict competition.

Advocacy initiatives, such as this market study, can be effective tools to help regulators and policymakers understand the competitive dynamics of an industry and the potential impacts regulations or policy may have on competition. In the context of this study, they provide information and analysis so that competition considerations can be balanced as appropriate with other legitimate policy objectives. At the same time, the Bureau recognizes that market failures do occur.

In circumstances where market forces do not adequately correct market failures, regulation can be used to determine outcomes or control market dynamics. Regulation is also used to protect against negative externalities that may be left unaddressed by market forces. But, in some cases, regulation can have unintended consequences including decreased efficiency and competition in a marketplace.

The analysis and recommendations found in this study report are made with these assumptions in mind. Second, the sector itself is an important pillar in the Canadian economy. The financial crisis damaged the reputation of the financial services sector and the sector appeared poised for an innovation disruption. Today, new entrants and incumbents alike are using technology to innovate and change the way Canadians access and consume financial products and services. Despite the global attention FinTech is generating, Canada lags behind its peers in its adoption.

Footnote 1. The Bureau sought to understand why FinTech adoption appears to be higher in other jurisdictions than in Canada. To ensure relevance for Canadians, this study focuses on innovations that affect the way Canadian consumers and SMEs commonly encounter financial products and services, with a focus on three broad service categories:. The Bureau did not include the following in this study:.

For each of the three areas studied—payments and payment systems, lending and investment dealing and advice—the Bureau drew conclusions and formed recommendations for financial sector policymakers, regulators, industry participants, SMEs and consumers. To help inform this study, the Bureau relied on information from a number of different sources. It reviewed public information such as academic literature, media publications, studies and reports from government agencies and other sources. The Bureau thanks everyone who took the time to provide information and advance this study to completion.

A draft report was released for public comment in November resulting in 30 responses from individuals, businesses and associations. The workshop proved to be an important opportunity for the Bureau to advance the discussion of relevant marketplace issues from a variety of perspectives.

With the current wave of FinTech still in its nascent stage, statistical data from which sound inferences could be made was not readily available. The Bureau relied primarily on submissions from and interviews with industry participants, regulators and industry groups as well as desk research to guide the analysis contained in this study. The Bureau examined the landscape through a competition lens to assess the likely impact of current regulation on innovation and competition, taking into account the important goals such regulation tries to achieve. From this analysis, the Bureau developed recommendations that focused on reducing or removing barriers to innovation and competition by supporting and encouraging FinTech development and growth.

The speed with which FinTech developments are occurring on a global basis may affect the relevance of some elements of the analysis. Nonetheless, the fundamentals of a competitive marketplace will continue to be relevant into the future and policymakers are encouraged to continuously consider the implications of their frameworks on competition. This report is divided into six parts. The introduction provides the competition context, discusses the important role regulation plays in the financial services sector and presents, in brief, recommendations primarily for financial sector policymakers and regulators.

The three chapters that follow discuss each of the highlighted service categories: payments and payment systems, lending and investment dealing and advice. The report then presents global reactions to FinTech and some of the solutions to encourage FinTech innovation around the world, accompanied by a discussion of the relevance that such measures could have for Canada.

Competition generally leads to higher levels of efficiency and living standards, helps deal with the unexpected, provides resiliency and stokes innovation. They also provide consumers with competitive prices, more product choices and the information needed to make informed purchasing decisions. The Bureau believes that market forces should be relied upon as much as possible to deliver these outcomes. While rapid technological advancement can accelerate innovation, regulation that does not keep pace can counteract that by impeding market forces from delivering competitive benefits.

This can ultimately inhibit innovation and lead to higher prices and less choice for consumers. Regulatory compliance can act as a significant barrier for new competitors who wish to enter a market or for existing competitors who wish to innovate outside the confines of regulation. Regulation must strike an appropriate balance between competition and the policy objectives it aims to achieve e.

This balance will allow consumers and businesses to benefit from a competitive marketplace while mitigating market failures. In a competitive marketplace, companies use different approaches to maximize their profits. Some reduce prices, while others exploit more efficient means of production to increase margins and reduce costs.

Others gain market share through innovation, offering consumers differentiated products and services that deliver more value than those of their competitors. When companies attempt to increase profits by raising prices, they risk losing customers to their competition or attracting new competitors who see the opportunity for profitable market entry. In markets that lack competition or where the threat of competitive entry is low, firms can maximize profits by increasing prices, without the same risk of losing customers. In these markets, the competitive drive to innovate, improve quality or become more efficient in production is largely lost.

Consumers ultimately pay higher prices without a commensurate improvement in value. Such uncompetitive outcomes are more likely when a market is characterized by a high concentration of suppliers, high barriers to entry and high costs of switching for customers. There are a few key elements that create an environment in which competition can flourish: low barriers to entry; low costs of switching for customers; complete and accurate information; and a sufficient number of effective competitors.

Without these elements, markets are likely to tend away from competitive outcomes. In markets with low barriers to entry, incumbent firms must keep prices low, exploit efficiencies and continuously innovate. If they do not, they face the risk of new entrants with better prices, more efficient production, more innovative offerings or some other value proposition for consumers coming into the market and decreasing their profits.

In contrast, when barriers are high, incumbent firms are less likely to face the threat of competitive entry and can more easily earn profits in excess of what a competitive firm would earn, reducing the incentive to innovate. High barriers to entry effectively protect incumbent firms from future competition—and the innovation from new entrants or incumbents that may come with it. Competitive entry can take different forms: a completely new firm e.

Barriers to entry affect the timeliness, likelihood and sufficiency of competitive entry. Whether they take the form of absolute restrictions on entry or individually small but cumulatively large deterrents, barriers to entry deter competition by making it too costly or risky to enter the market profitably. Barriers to entry can include: regulatory barriers, high sunk costs e.

When consumers can switch between suppliers easily and for low or no cost, firms have the incentive to keep prices low or otherwise maintain value for their customers. If not, they risk losing customers to a competing firm. When it is difficult for customers to switch between suppliers or when doing so does not generate sufficient benefits to outweigh the costs of switching , customers are less likely to switch even if prices increase. To help customers make switching decisions and indeed purchasing decisions generally, information presented to consumers should be complete, accurate and presented in a manner that is easily understood.

Where pricing and related information is opaque, confusing, false or misleading e. As a result, businesses do not have to compete as vigorously to keep customers. A competitive market needs competitors. Mature industries with high barriers to entry and sticky customers can often result in concentrated marketplaces with a few large suppliers and potentially a competitive fringe. As the Internet and mobile computing have become ubiquitous, consumer demand for new ways to deliver financial services has increased. Widespread use of the Internet would be expected to increase competition, given that one of the largest barriers to entry—the need for a branch network—is reduced.

However, many other barriers remain in the way of FinTech entry into the financial services marketplace, including:.


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Consumer awareness and demand for products are barriers that all new businesses face. As consumers learn more about FinTech and begin to demand more innovative solutions in financial services, one would expect these barriers to be more easily overcome. Consumers of financial services want to ensure their money is safe, their investments grow and their payments are made on time.

As a result, new entrants can find it particularly challenging to win the trust of consumers and build reputations as safe and reliable service providers. In addition, most of the target market is already served in some capacity by seemingly similar services e.

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The integration of financial services into our daily lives heightens the risks associated with the uncertainties inherent in trying a new product. Additionally, fees and penalties for switching increase the costs and difficulty for consumers, which makes adoption of new services or products less likely to happen quickly.

Related to customer stickiness, building "economies of scale" refers to the ability of FinTech companies to gain the necessary critical mass of users on all sides of transactions to make their services profitable and maintain the cost advantages expected from avoiding costly branch networks. Incumbent financial service providers have an advantage in that they have the customer base and capital to experiment with new offerings without the same consequences of failure. Finally, regulation may present a barrier to market entry and success for FinTech companies.

The financial services and banking sectors are heavily regulated at the federal and provincial levels. Although these regulatory frameworks are unquestionably important in safeguarding consumers and mitigating risks to the financial system as a whole, they can inadvertently deter innovation and the competitive benefits that follow. Given the impact regulation can have on entry and competition in the marketplace, the primary focus of this study is on the regulatory barriers to entry faced by FinTech. Throughout this study, the Bureau heard from many stakeholders about the issues different regulations pose for FinTech.

The majority of regulatory barriers can be divided into four categories:. The goal of most regulation is to correct for negative externalities that will not be corrected by market forces alone. Regulation also plays a role in mitigating risks that may be ignored when companies pursue higher profitability. Risks that regulation in financial services aims to mitigate include systemic risk i. In this context, financial services regulations exist to protect the systems in place and to govern the conduct of those who provide services.

Part 1 of the infographic is an organizational chart that illustrates the relationship between Canada's federal financial regulators and policymakers. The title of the infographic is "Canadian regulatory landscape. At the top of the organizational chart are the Minister of Finance and the Bank of Canada.

The Minister of Finance and the Department of Finance Canada are responsible for fiscal policy and financial sector regulatory policy and legislation.


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The Bank of Canada is also part of the finance portfolio but is responsible for setting monetary policy independently. The Minister of Finance oversees a number of agencies and Crown corporations in the finance portfolio which is represented by the second tier of the organizational chart. Payments Canada is also represented alongside the aforementioned second-tier agencies and corporations but is distinct in its connection to the Bank of Canada, as the Bank of Canada is also responsible for overseeing Canada's major clearing and settlement systems, some of which are operated by Payments Canada.

This is represented by the second-tier which outlines responsibilities in three broad categories: provincially or territorially regulated financial institutions such as most credit unions , securities and consumer protection. While the Minister of Finance sets policy and creates legislation, these agencies and corporations carry out the administration or enforcement of that legislation.

The Bank of Canada is responsible for setting monetary policy in Canada, targeting inflation through manipulation of overnight interest rates i. It oversees major clearing and settlement systems, providing those systems with banking services pursuant to the Payment Clearing and Settlement Act ; promotes financial stability globally with international bodies; and provides liquidity to the financial system. The Bank of Canada is also responsible for issuing currency.

Some of the primary risks concerning the Bank of Canada include the safety, soundness, stability and efficiency of the financial system. FRFIs include all banks in Canada as well as all federally incorporated or registered trust and loan companies, insurance companies, cooperative credit associations, fraternal benefit societies and private pension plans. The FCAC ensures that federally regulated financial institutions i. It also conducts research and promotes financial education and awareness of consumer rights and responsibilities.

The CDIC is a federal Crown corporation that contributes to the stability of the financial system by providing deposit insurance against the loss of eligible deposits at member institutions in the event of their failure. Premiums for deposit insurance are paid by member institutions. In addition to direct government involvement, Payments Canada Footnote 5 has a legislative mandate and is responsible for the clearing and settlement infrastructure, processes and rules that are essential to the exchange of billions of dollars each day i.

Payments Canada operates three payments systems:. The organization also oversees the rules for this key payments infrastructure and ensures its smooth and efficient operation. Footnote 6 Most provinces and territories also have consumer protection legislation, some of which deals with financial transactions and agreements. In relation to the three areas that are the focus of this study—payments and payment systems, lending and investment dealing and advice—securities laws have a significant impact on the entry and growth of FinTech.

The goal of securities legislation is to foster fair and efficient capital markets and protect investors. Securities rules include regulation of the conduct of securities issuers and dealers as well as their reporting requirements and business structures. To harmonize, improve and coordinate securities legislation and regulation across jurisdictions, each of the provincial and territorial securities regulators have combined to create the Canadian Securities Administrators CSA umbrella organization.

Each of these regulatory or oversight authorities has an important role to play in ensuring that financial markets are safe, secure, efficient and useful to Canadians. They promote confidence in the financial system through consumer protection and literacy, while mitigating exposure to unnecessary risks. There is no doubt they are important and necessary to the operation of our financial system. Throughout this study, the Bureau heard from a wide variety of stakeholders regarding innovation and competition in the financial services sector.

Given the barriers identified in this study report, the Bureau recommends the following be adopted by financial sector regulatory authorities and policymakers to ensure that, wherever possible, regulatory responses to FinTech balance the need for protection against risk with competition and innovation:. The Bureau is confident that these recommendations, if adopted, would facilitate competition through innovation to the benefit of Canadians. If given the opportunity, FinTech innovation in retail payments will deliver consumer and business products and services that go beyond just finding a new way to tap the same credit card.

A payments system that is safe, secure and efficient is the backbone of our financial system. Most of these transfers require an underlying infrastructure with accompanying instruments, technical arrangements, procedures and rules to facilitate the exchange of value between the party making the payment the payer and the party receiving the payment the payee. These elements make up the retail payments system. At a high level, the retail payments space is composed of two key pieces: the infrastructure that ensures payments are cleared and settled specifically, the Automated Clearing Settlement System [ACSS] and Large Value Transfer System [LVTS] along with the various payment schemes and services e.

Given the critical importance of the payments system, a strong regulatory framework is needed to ensure payments are made and received in a safe, secure and expedient way. Yet, these important regulatory constructs can sometimes have unintended consequences that slow innovation and reduce competition. Retail payment systems are a combination of interrelated processes and networks.

These networks have a vertical relationship, moving from downstream services to upstream payments infrastructure for clearing and settlement. For these systems to operate effectively and efficiently, they are bound by rules that all participants must follow. Different payment schemes use different processes, infrastructure and rules to effect payments.

The counterparty risk of cheques is eliminated. Email money transfers operate in the same general way as payments using debit cards but they operate a proprietary network for clearing payments before being settled through the LVTS. Electronic funds transfers e. Cheques, debit transactions and electronic funds transfers through financial institutions are all cleared and settled through the ACSS. Cheques and other paper instruments make up the largest proportion of the value of retail payments, with electronic funds transfers following closely behind.

The general trend, however, is toward less reliance on cash and cheques in favour of credit cards and electronic funds transfers. As payments move away from costly instruments such as cash and cheques , demands for payment services are changing. New PSPs are entering this space, using technology and innovative business models to meet these demands. According to the Basel Committee on Banking Supervision, the retail payments industry has also attracted the most new entry from FinTech companies globally.

These new entrants have the opportunity to increase competition in the marketplace. To understand the potential of FinTech to provide effective competition in the retail payments space, it is important to understand how competition happens in the industry today. Given the complexity of retail payments, competition occurs in a number of ways at various points along a payment journey: from the service that allows initiation of the payment, to the network used to facilitate the payment, to the institutions that process and clear transactions.

At each stage of a payment, there is opportunity for innovation and competition to deliver better results for Canadians. In many cases, PSPs share upstream clearing and settlement infrastructure but compete downstream by offering payment services directly to end users e.

Members of a clearing and settlement system, such as the ACSS, may also compete with one another to provide clearing and settlement services to smaller members, who may not be able to afford to clear and settle directly with the ACSS, or to institutions that are excluded from the ACSS. Downstream competitors provide an interface between the users of payment services and the clearing and settlement process.

These downstream competitors offer a wide range of services to both consumers and businesses. The majority of competition in the retail payments space is downstream, with both new entrants and incumbents competing on price and service levels. Despite a relatively high degree of consolidation, competition is generally strong in the "merchant acquiring" marketplace. Merchant acquirers provide the infrastructure and services that merchants use to accept and process retail payments. This infographic summarizes how different firms can provide payment services to end users in Canada.

The title of the infographic is "Overview of competitive dynamics in the retail payments space. There are a number of ways competition can occur at the various points along a payment journey, falling into three general categories:. Different payment schemes e. Many different payment schemes exist in parallel, including debit card, credit card and closed-loop payment schemes, allowing different firms to provide payment services,.

This dynamic of competition is called "inter-network competition". Some of these schemes may rely on a direct clearer to transfer funds between account-holding institutions. Closed loop payment schemes, however, do not rely on a direct clearer in order to transfer funds between account-holding institutions. Certain members of a payment scheme using the ACSS connect directly to the system to process payments direct clearers , while others connect indirectly indirect clearers. The Bank of Canada provides clearing and settlement services to direct clearers, while direct clearers can offer clearing and settlement services to indirect clearers as clearing agents.

Competition between clearing agents to offer these services is "intra-network competition upstream. All members of a particular payment schemes, including direct clearers, clearing agents, and indirect clearers, however, can provide payment services to end users. This level of competition is referred to as "intra-network competition downstream. Payment systems often offer different features or qualities including security, convenience, reliability, timeliness, cost, the ability to draw on a credit facility and the ubiquity of users on both sides of the transaction i.

Because no two retail payment instruments are seen as being perfect substitutes, the retail payments marketplace has several competing payment systems. Given the features of a certain payment instrument, however, end users can typically be serviced by multiple competing providers. The potential for FinTech in the payments space to circumvent traditional institutions is real. But to be successful, PSPs need to bring enough users on both sides of a payment to their service to offer a truly competitive option. Mobile payments, for example, are an innovation through which new competitors have emerged.

Many PSPs, including financial institutions, have developed their own mobile wallet applications and technology companies, such as Apple though iOS and Google through Android have introduced mobile wallets that allow end users to make retail payments with their mobile phones at physical POS terminals. Mobile payments allow for increased competition from new entrants , as they can reduce or eliminate the physical limitations on the number of cards that can be carried or used feasibly by end users.

Mobile credit card processing products, for example, allow merchants who may have historically relied on cash or cheques to accept a wider variety of payment methods, Footnote 12 reducing counterparty risk for merchants and improving convenience for consumers. These entrants are increasingly providing competition for the initiation of payments, eliminating the visibility of financial institutions to end users.

Footnote 13 Only when a user decides to withdraw funds from their PayPal account or load funds into their account do financial institutions become a part of the payment journey. Payments between two parties seeking to send and receive money in different countries are in effect made through two domestic transfers. The PSP transfers funds between the payer and itself in one country and, at the same time, transfers the reciprocal amount between itself and the payee in the other country.

Again, this process avoids the need for a financial institution to initiate the exchange of funds. Footnote 15 Competition between payment systems can also reduce the overall price level for payment services, with new players offering systems that leverage technology and innovation to provide these services at lower prices than existing systems.

Canadians are increasingly using credit cards as a payment method rather than a source of financial credit. The funding for these services and features comes from part of the fee levied on merchants for all purchases made using credit cards. Footnote 16 Credit cards that provide "premium" benefits often carry a higher fee.

If they are given the opportunity to develop the necessary scale, new FinTech entrants offering alternative payment methods may put downward pressure on these fees or provide better value in other dimensions e. To achieve that scale, short of direct price regulation, merchants must have the ability to adequately incentivize consumers to adopt alternative, less costly, payment methods. FinTech entrants in the retail payments space, however, face significant barriers to entry that may slow innovation and, in the extreme, prevent these benefits from being achieved.

Some of these barriers are directly attributable to regulation—that is, the regulations themselves may create barriers to entry. In other cases, the barriers are not attributable to regulation but may indeed benefit from a regulated solution. The Bureau conducted extensive stakeholder engagement over the course of this study to identify the barriers to entry and growth faced by new firms entering the market as well as incumbent firms seeking to expand or compete with new entrants.

These barriers include consumer behaviour and market maturity, the impact of network effects and the need for economies of scale and access to core banking services that are needed to underpin a FinTech product or service. Some of these barriers must be overcome by the firms wishing to enter on their own, while others may require regulatory intervention to be overcome. A key to success for a new PSP is penetration and adoption rates by both consumers and businesses. While innovations such as mobile payments are relatively new, early estimates suggest adoption and usage rates have been lower than initially estimated.

Industry participants told the Bureau that consumers have a high degree of trust in the existing payment card infrastructure and believe that they are well serviced by it. Footnote 17 As a result, consumers' willingness to switch to a mobile wallet is currently limited. One industry participant suggested it will take years, rather than months, to change consumer behaviour. Some participants suggested that creating a digital copy of a user's credit or debit card on their mobile phone was not enough of an incentive to drive adoption.

Research on mobile payment adoption in Canada has cited similar barriers. A Bank of Canada research report highlights low rates of mobile payment acceptance by Canadian businesses. Another merchant association indicated that, while there had been some uptake, there had also been a "fair bit of reluctance" by some merchants to enable online payments.

A report from Innovation, Science and Economic Development Canada highlights similar statistics. As a result, demand for new forms of payments may not be sufficiently significant to attract new entry. As for why this may be the case, merchant associations noted that control of consumers' payment data and related concerns such as security and liability were not adequately understood by or clear to merchants.

Merchant concerns over the potential for penetration pricing Footnote 18 have also caused some delay in adoption. To overcome this barrier, FinTech entrants will need to prove the utility of their product or service to a wide range of users on both sides of a transaction. There are also barriers to consumers and merchants switching between payment services driven largely by the distinct economic characteristics of retail payments. Network effects can cause firms in two-sided markets to employ strategies to attract users on both sides of a payment—consumers to use a particular payment method and merchants to accept it.

Such strategies would take into account the relative elasticities of demand of both consumers and merchants—merchants typically accept multiple payment methods, while consumers tend to favour one in particular, in many cases credit cards. This preference by consumers can contribute to higher costs for merchants and higher prices on goods and services if merchants recover these costs. For example, some rewards programs effectively pay consumers for using their credit card. Given the critical importance of the payments system, a strong regulatory framework is needed to ensure payments are made and received in a safe, secure and expedient way.

Yet, these important regulatory constructs can sometimes have unintended consequences that slow innovation and reduce competition. Retail payment systems are a combination of interrelated processes and networks. These networks have a vertical relationship, moving from downstream services to upstream payments infrastructure for clearing and settlement. For these systems to operate effectively and efficiently, they are bound by rules that all participants must follow. Different payment schemes use different processes, infrastructure and rules to effect payments.

The counterparty risk of cheques is eliminated. Email money transfers operate in the same general way as payments using debit cards but they operate a proprietary network for clearing payments before being settled through the LVTS. Electronic funds transfers e. Cheques, debit transactions and electronic funds transfers through financial institutions are all cleared and settled through the ACSS. Cheques and other paper instruments make up the largest proportion of the value of retail payments, with electronic funds transfers following closely behind.

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The general trend, however, is toward less reliance on cash and cheques in favour of credit cards and electronic funds transfers. As payments move away from costly instruments such as cash and cheques , demands for payment services are changing. New PSPs are entering this space, using technology and innovative business models to meet these demands. According to the Basel Committee on Banking Supervision, the retail payments industry has also attracted the most new entry from FinTech companies globally.

These new entrants have the opportunity to increase competition in the marketplace. To understand the potential of FinTech to provide effective competition in the retail payments space, it is important to understand how competition happens in the industry today. Given the complexity of retail payments, competition occurs in a number of ways at various points along a payment journey: from the service that allows initiation of the payment, to the network used to facilitate the payment, to the institutions that process and clear transactions.

At each stage of a payment, there is opportunity for innovation and competition to deliver better results for Canadians. In many cases, PSPs share upstream clearing and settlement infrastructure but compete downstream by offering payment services directly to end users e. Members of a clearing and settlement system, such as the ACSS, may also compete with one another to provide clearing and settlement services to smaller members, who may not be able to afford to clear and settle directly with the ACSS, or to institutions that are excluded from the ACSS.

Downstream competitors provide an interface between the users of payment services and the clearing and settlement process. These downstream competitors offer a wide range of services to both consumers and businesses. The majority of competition in the retail payments space is downstream, with both new entrants and incumbents competing on price and service levels. Despite a relatively high degree of consolidation, competition is generally strong in the "merchant acquiring" marketplace.

Merchant acquirers provide the infrastructure and services that merchants use to accept and process retail payments. This infographic summarizes how different firms can provide payment services to end users in Canada. The title of the infographic is "Overview of competitive dynamics in the retail payments space. There are a number of ways competition can occur at the various points along a payment journey, falling into three general categories:.

Different payment schemes e. Many different payment schemes exist in parallel, including debit card, credit card and closed-loop payment schemes, allowing different firms to provide payment services,. This dynamic of competition is called "inter-network competition". Some of these schemes may rely on a direct clearer to transfer funds between account-holding institutions. Closed loop payment schemes, however, do not rely on a direct clearer in order to transfer funds between account-holding institutions.

Certain members of a payment scheme using the ACSS connect directly to the system to process payments direct clearers , while others connect indirectly indirect clearers. The Bank of Canada provides clearing and settlement services to direct clearers, while direct clearers can offer clearing and settlement services to indirect clearers as clearing agents. Competition between clearing agents to offer these services is "intra-network competition upstream.

All members of a particular payment schemes, including direct clearers, clearing agents, and indirect clearers, however, can provide payment services to end users. This level of competition is referred to as "intra-network competition downstream. Payment systems often offer different features or qualities including security, convenience, reliability, timeliness, cost, the ability to draw on a credit facility and the ubiquity of users on both sides of the transaction i.

Because no two retail payment instruments are seen as being perfect substitutes, the retail payments marketplace has several competing payment systems. Given the features of a certain payment instrument, however, end users can typically be serviced by multiple competing providers. The potential for FinTech in the payments space to circumvent traditional institutions is real. But to be successful, PSPs need to bring enough users on both sides of a payment to their service to offer a truly competitive option. Mobile payments, for example, are an innovation through which new competitors have emerged.

Many PSPs, including financial institutions, have developed their own mobile wallet applications and technology companies, such as Apple though iOS and Google through Android have introduced mobile wallets that allow end users to make retail payments with their mobile phones at physical POS terminals. Mobile payments allow for increased competition from new entrants , as they can reduce or eliminate the physical limitations on the number of cards that can be carried or used feasibly by end users. Mobile credit card processing products, for example, allow merchants who may have historically relied on cash or cheques to accept a wider variety of payment methods, Footnote 12 reducing counterparty risk for merchants and improving convenience for consumers.

These entrants are increasingly providing competition for the initiation of payments, eliminating the visibility of financial institutions to end users. Footnote 13 Only when a user decides to withdraw funds from their PayPal account or load funds into their account do financial institutions become a part of the payment journey.

Payments between two parties seeking to send and receive money in different countries are in effect made through two domestic transfers. The PSP transfers funds between the payer and itself in one country and, at the same time, transfers the reciprocal amount between itself and the payee in the other country. Again, this process avoids the need for a financial institution to initiate the exchange of funds.

Footnote 15 Competition between payment systems can also reduce the overall price level for payment services, with new players offering systems that leverage technology and innovation to provide these services at lower prices than existing systems. Canadians are increasingly using credit cards as a payment method rather than a source of financial credit. The funding for these services and features comes from part of the fee levied on merchants for all purchases made using credit cards. Footnote 16 Credit cards that provide "premium" benefits often carry a higher fee. If they are given the opportunity to develop the necessary scale, new FinTech entrants offering alternative payment methods may put downward pressure on these fees or provide better value in other dimensions e.

To achieve that scale, short of direct price regulation, merchants must have the ability to adequately incentivize consumers to adopt alternative, less costly, payment methods. FinTech entrants in the retail payments space, however, face significant barriers to entry that may slow innovation and, in the extreme, prevent these benefits from being achieved. Some of these barriers are directly attributable to regulation—that is, the regulations themselves may create barriers to entry.

In other cases, the barriers are not attributable to regulation but may indeed benefit from a regulated solution. The Bureau conducted extensive stakeholder engagement over the course of this study to identify the barriers to entry and growth faced by new firms entering the market as well as incumbent firms seeking to expand or compete with new entrants.

These barriers include consumer behaviour and market maturity, the impact of network effects and the need for economies of scale and access to core banking services that are needed to underpin a FinTech product or service. Some of these barriers must be overcome by the firms wishing to enter on their own, while others may require regulatory intervention to be overcome. A key to success for a new PSP is penetration and adoption rates by both consumers and businesses.

While innovations such as mobile payments are relatively new, early estimates suggest adoption and usage rates have been lower than initially estimated. Industry participants told the Bureau that consumers have a high degree of trust in the existing payment card infrastructure and believe that they are well serviced by it.

Footnote 17 As a result, consumers' willingness to switch to a mobile wallet is currently limited. One industry participant suggested it will take years, rather than months, to change consumer behaviour. Some participants suggested that creating a digital copy of a user's credit or debit card on their mobile phone was not enough of an incentive to drive adoption. Research on mobile payment adoption in Canada has cited similar barriers.

A Bank of Canada research report highlights low rates of mobile payment acceptance by Canadian businesses. Another merchant association indicated that, while there had been some uptake, there had also been a "fair bit of reluctance" by some merchants to enable online payments. A report from Innovation, Science and Economic Development Canada highlights similar statistics. As a result, demand for new forms of payments may not be sufficiently significant to attract new entry. As for why this may be the case, merchant associations noted that control of consumers' payment data and related concerns such as security and liability were not adequately understood by or clear to merchants.

Merchant concerns over the potential for penetration pricing Footnote 18 have also caused some delay in adoption. To overcome this barrier, FinTech entrants will need to prove the utility of their product or service to a wide range of users on both sides of a transaction. There are also barriers to consumers and merchants switching between payment services driven largely by the distinct economic characteristics of retail payments. Network effects can cause firms in two-sided markets to employ strategies to attract users on both sides of a payment—consumers to use a particular payment method and merchants to accept it.

Such strategies would take into account the relative elasticities of demand of both consumers and merchants—merchants typically accept multiple payment methods, while consumers tend to favour one in particular, in many cases credit cards. This preference by consumers can contribute to higher costs for merchants and higher prices on goods and services if merchants recover these costs.

For example, some rewards programs effectively pay consumers for using their credit card. Footnote 19 As a result, credit card payments made in Canada are the most expensive form of retail payment for merchants to accept. Footnote Yet many merchants still accept credit cards due to consumers' preference to use them and potential for lost sales to competitors who do accept them , despite credit cards being the most expensive form of payment for merchants to accept. Once a merchant decides which payment methods they will accept, they have "relatively limited influence on the use of payment methods at the POS.

While consumers are incentivized to switch payment methods, for example, through direct appeals e. Credit card issuers may also lack the incentive to promote lower-cost payment methods as they may lead to a reduction of interchange revenues earned from credit card usage. The Code of Conduct also states that merchants are able to provide discounts for using different methods of payment. However, until recently merchants lacked the ability to surcharge for the use of credit cards that may be costly to merchants but attractive to consumers.

A settlement between the large credit card networks and a class of Canadian merchants will open the door to surcharging. With few merchants providing discounts and only the recent introduction for potential surcharging, consumers do not see the benefit of using different payment methods that are less costly for merchants when they are earning rewards at no direct or obvious cost. There may actually be a cost—and it is borne by all consumers in the form of higher prices for goods and services.

Ultimately, when consumers favour a single payment method as has been the case with credit cards , it creates a barrier to entry for competing payment methods. Furthermore that barrier is exacerbated by the need for a payment method to attract consumers and merchants. When merchants apply discounts or surcharges to influence consumer choice, new entrants may enter the market. International policymakers have taken different approaches to address the competitive dynamics of the payments space.

For example, reducing interchange fees in an effort to reduce barriers to entry and lower the costs for merchants to accept credit cards. Australia introduced new interchange standards in of 0. These stakeholders also noted to the Bureau that it was unclear whether any cost savings had been passed on to consumers, or whether consumer payment habits have changed to the degree that would have been anticipated.

At the same time, negative externalities such as excessive surcharging have been corrected using regulatory levers. The European Union introduced similar regulation in to cap interchange fees at 0. An additional impediment to adopting or switching to a new payment service is the lack of interoperability between platforms and devices. Too many options may leave consumers unclear on what payment options are accepted where—and merchants with too many payments services to manage efficiently. Interoperability will be essential to ensuring consumers are able to pay with the instrument of their choice and merchants are able to accept a wide variety of payment options with minimal hardware or administrative investment.

To this end, some degree of collaboration between market participants may be necessary to create an environment where competition between PSPs can flourish. At times, FinTech entrants are competing with the financial institutions from which they require these services. During this study, several FinTech entrants expressed difficulty in obtaining the basic banking services required to operate.

With few institutions willing to provide services to MSBs, these entrants have faced delays in getting banking services set up as well as the termination of their services with little or no explanation. As such, incumbents are in a position where they can effectively block the entry of any new competition.

There can be legitimate reasons for a financial institution to refuse to provide account services to a business or PSP e. At the same time, financial institutions could potentially use their position to refuse to provide account services for competitive reasons. Footnote 21 The lack of transparency in the reason for these decisions or the availability of recourse for those denied account services makes it unclear what needs to be remedied in order to obtain service.

The refusal of banking services can add to the sunk and ongoing costs of entry for new firms, resulting in ineffective or delayed entry. These issues are not unique to Canada. Regulators in other jurisdictions have taken note of the increasing difficulty MSBs and FinTech firms face when opening and maintaining a bank account.

The FCA suggests that " banks should not use AML as an excuse for closing accounts when they are closing them for other reasons. Regulation in the retail payments space covers the core infrastructure such as the ACSS and the schemes using that infrastructure. Consumer protection regulation also covers the credit and debit payment card networks. Given the risks associated with failure or misuse of the payments system, appropriate regulation is imperative.

Unfortunately, regulation can unintentionally create barriers to innovation and competition. In , the Department of Finance Canada released a consultation paper proposing a new oversight framework for national retail payments systems:. The current oversight of payment systems in Canada is focused on the core national payment clearing and settlement systems and, to a lesser extent, on retail payment systems supported by regulated financial service providers such as debit and credit card networks.

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The Department of Finance Canada outlined its proposed New Retail Payments Oversight Framework in —guided by the four principles of necessity, proportionality, consistency and effectiveness —and invited comments on its components, specifically asking whether the framework would sufficiently promote innovation and competition.

Rather, the current oversight framework focuses on incumbent and traditional PSPs e. Regulatory uncertainty adds to the sunk costs as well as the risks involved in entering a market, particularly for smaller firms with limited resources. New entrants expressed their desire for appropriate regulatory oversight. Having "clearly defined parameters for market players" is an important step toward enabling effective competition. Reducing the costs, time and risks associated with market entry will encourage competition and spur innovation.

At the same time, incumbent industry participants noted that new entrants were not subject to the same regulatory oversight despite providing materially similar services. In a staff discussion paper from the Bank of Canada , some suggested this allows new entrants to innovate outside the regulatory purview, putting incumbents at a competitive disadvantage. New entrants believe end users would be more likely to switch services if they knew alternative providers were subject to the same regulations as incumbents.

Because many issues pertaining to retail payments remain unaddressed by regulation, the industry relies on contractual agreements between end users and PSPs in areas such as consumer protection. Footnote 22 Regulation, in this case, may help entrants overcome trust barriers by instilling confidence in different payment schemes.

Regulation should, however, be minimally intrusive to market forces. While regulation can reduce some barriers to entry by instilling confidence and bridging the trust gap, it can also erect other barriers to entry for new firms and inadvertently inhibit competition and innovation. Many industry participants—new entrants and incumbents alike—said regulation should be based on the function a firm carries out rather than the definition of an entity in a regulation.

The framework should also be proportionate in nature. While many firms perform similar functions, they may not pose the same level of systemic risk. Therefore, requirements that apply equally to all firms e.

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The Bureau welcomes a tiered approach to regulatory measures and views industry participants as well positioned to inform the setting of specific requirement tiers. These advantages are amplified by the fact that new PSPs cannot access the core clearing and settlement systems underpinning these networks. While firms who invest in building out their networks should benefit from their investments, access to the underlying payments infrastructure around which these networks are built continues to be a barrier to effective competition by new entrants.

The Canadian Payments Act outlines institutional restrictions on required and eligible membership. Footnote 24 Payments Canada members then face additional restrictions to accessing the exchange, clearing and settlement functionality of the ACSS as "direct clearers.

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Restrictions on participation and operational risk requirements exist to ensure that participants do not pose risk to other participants, the system or the Bank of Canada. Footnote 26 The restrictions for direct clearers in the ACSS, for example, exist because of its design as a deferred net settlement DNS arrangement for clearing and settlement. Given the critical importance of direct settlement and the size of the average daily obligations cleared in the ACSS, direct clearers must be able to assume a significant degree of credit risk.

As a result, there is a high degree of mutual trust among the small number of participating institutions to extend credit to each other. In a less homogenous pool of direct clearers, individual participants may use significantly different mechanisms for managing risk, resulting in a more complex and inefficient payment system. Specifically, potential direct clearers in the ACSS must maintain a settlement account and loan facility with the Bank of Canada. They must also have payment volumes of at least 0. Footnote 27 The number of direct clearers has effectively been limited to just 12 institutions due to the volume threshold of payments cleared through the ACSS.

In contrast, an "indirect clearer" in the ACSS is a Payments Canada member that does not maintain a settlement account or loan facility at the Bank of Canada. Indirect clearers establish a settlement account and loan facility with a direct clearer, which acts as its "clearing agent. These restrictions and the limited direct participation resulting from them can, however, have a negative impact on competition.

FinTech entrants, indirect clearers and direct clearers all compete in end user markets and as a result, can face a significant degree of agency risk by not connecting directly to the system. While this may be inadvertent, clearing agents have a stronger incentive to impose costs strategically when they compete directly in end user markets with indirect clearers.

In the past, indirect clearers selected end user markets in a way that minimized or avoided direct competition with clearing agents. Footnote 30 However, a large number of the new entrants in the payments space provide services in direct competition with incumbent direct clearers and clearing agents. In response, an increasing number of financial institutions may be unwilling to provide their competitors with access to the ACSS.

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Footnote 31 This directly affects the ability of FinTech entrants to compete with incumbents for end users. In the event that FinTech entrants have been able to secure services from a financial institution, they face an increased level of agency risk that then influences their downstream service level and competitiveness. As they are currently ineligible for membership in Payments Canada, FinTech entrants with whom the Bureau spoke said they cannot access the ACSS directly in any capacity whether for exchange, clearing or settlement.

In many cases, direct access to only the exchange function would be sufficient to alleviate this major barrier to entry. For example, the criteria for accessing the exchange function could be more lenient than access to clearing or settlement. A similar model in the UK resulted in a significant increase in the number of new entrants pursuing this method of direct access. Footnote 33 While many of the ACSS direct clearers act as clearing agents, only two actively pursue the business of providing services to indirect clearers or those excluded from Payments Canada.

Limited choice in clearing agents reduces the ability of indirect clearers to switch easily between clearing agents resulting in little competition between clearing agents. Some industry participants suggested that by easing the barriers to entry for direct clearers, competition between clearing agents would improve, either as the result of the entry of one or more firms focused on providing wholesale services or simply due to the legitimate threat of entry of a new player.

It is important to ensure the various forms of risk with the payment system are adequately mitigated and controlled and Canada may learn from the experience in other jurisdictions, where regulators have explored how to implement controls that achieve a better balance between competition and the safety and soundness of the system. The Bank of Canada and the Department of Finance Canada, in a discussion paper presented to Payments Canada then the Canadian Payments Association , highlighted similar competition issues caused by access restrictions and a potential lack of competition between clearing agents.

As a result, Payments Canada membership criteria was amended in through the Canadian Payments Act to make three new classes of financial institutions eligible including life insurance companies, securities dealers and money market mutual funds. Footnote 35 This, however, resulted in little change to the membership of Payments Canada that remains today. The paper highlighted that "many participants in the financial industry argue that the new competitive opportunities, and accompanying benefits for consumers, could be realized most fully only if they are able to have more direct involvement in the payments system.

Broader access to the ACSS, altering the Payments Canada membership criteria and creating a regulatory framework based on the functions carried out by a PSP can help mitigate the competitive impacts noted above, and increase the level of competition and innovation in payment services to the benefit of consumers and business. Once a network is in place, it is increasingly difficult for a firm to establish a competing network, as it would need to connect to enough financial institutions and end users on both sides of the market to establish a critical mass to support effective entry.

Interoperability can reduce the barriers to entry for new schemes, networks and infrastructure providers by helping them overcome challenges associated with network effects and economies of scale. The Single Euro Payment Area, for example, has created a marketplace where multiple infrastructure providers compete to process payments for PSPs throughout the Eurozone. This level of competition is achieved through interoperability, with all infrastructure providers having adopted a common messaging standard. Payments Canada will adopt the ISO payment messaging standard , which is already in use in many other jurisdictions around the world, as part of its modernization project.

The adoption of ISO will effectively lower the barriers to entry for infrastructure providers and payment schemes in jurisdictions utilizing that same standard, making it easier for them to enter the Canadian marketplace and provide services to end users, financial institutions and PSPs. A system with high interoperability, however, will require significant collaboration and coordination. Collaboration, in this context, can pose competition concerns. Competitors that collaborate upstream in designing the system may wish to reduce competition downstream for retail payment instruments and services by designing rules or technical specifications that prevent the entry of new or innovative firms.

Footnote 36 According to a London Economics report entitled Competition and Collaboration in UK payment systems, such rules may raise the cost of entry or assign a proportionately larger compliance cost to smaller firms. Given the collaboration necessary in any core system development, it is important that competition and innovation are encouraged in the downstream market and that system participants do not abuse their position in a way that would block the entry of a new player or harm their ability to provide a service.

In particular, governance should be independent of membership but take into consideration a wide range of stakeholders including incumbent and new entrant PSPs, merchants and consumers. Internationally, many jurisdictions have also separated the scheme level e. While restrictions on participation and operational risk controls are necessary in any core payment system, they may present a barrier to entry for new firms and increased competition. The design of the system, however, can have an impact on the necessary risk controls because different designs entail different risks.

Improving access to national payment systems is a key goal for policymakers internationally. Authorities in Australia and the UK have stressed the importance of competition in clearing and settlement services to ensuring an innovative payments ecosystem.

Policymakers abroad are trying to ensure regulation is designed in a way that promotes new entry. If the Canadian payments system is to remain competitive, policymakers in this country must keep pace with their international counterparts. Many FinTech firms with whom the Bureau spoke believe the regulatory environment in other jurisdictions such as the EU, the UK and Australia, is more welcoming and conducive to innovation.

While it remains to be seen what will come of the policy choices being made in these jurisdictions, Canadian policymakers may be well served to consider the direction of some of our peers. The Financial System Inquiry suggests that clearly graduated, functional regulation would facilitate innovation and competition in the payments system. Perhaps the most significant regulatory developments are occurring in the EU. The revised Payment Services Directive PSD2 aims to reduce the barriers to entry faced by new entrants providing payment services. PSD2 introduces a new licence for innovative PSPs that have emerged in several EU member states but were not recognized under the original Payment Services Directive, which came into force in This gap in regulation created legal uncertainty and regulatory challenges.

The European Commission, in an impact assessment, found that closing regulatory gaps in the original Payment Services Directive is expected to encourage entry and stimulate competition in electronic payments. Restrictions on access to crucial parts of the existing payments infrastructure applied by incumbent PSPs based on their market position present another major barrier to entry for new firms.

In many cases, banks in the EU have blocked third parties from accessing consumer payment accounts. It will also establish the obligations and liabilities of both parties. In the UK, the Payment Systems Regulator PSR views access to payment systems as a key enabler of competition and innovation in payments , noting that PSPs should be able to access systems on a fair, open and transparent basis and be able to do so in the way that they choose. The PSR has undertaken extensive work to ensure effective competition in the payments market by lowering barriers to entry and increasing the options available for payment systems access.

The PSR published a market review into the supply of indirect access to payment systems in July , highlighting specific concerns with the quality and limited choice of indirect access to payment systems as well as barriers to switching between indirect access providers. The keys to encouraging competition and continued innovation in the payments services space are access, awareness and ability to induce switching.

Specifically, broader access to core infrastructure such as the ACSS and the forthcoming real-time rail must be provided, along with access to banking services for PSPs; greater awareness of product and service options must be fostered among consumers and merchants; and merchants need the ability to apply discounts or surcharges to encourage consumers to choose alternative or lower-cost payment methods that would benefit both merchants e.

The Bureau has prepared several recommendations that policymakers, regulators and Payments Canada should consider continuing to ensure the payments system stays safe, secure and efficient. However, the responsibility to achieve these goals must be shared among policymakers, regulators, Payments Canada, industry participants, consumers and merchants. Agreements or arrangements that have the potential to prevent or lessen competition should be approved only in exceptional circumstances and where necessary to meet policy objectives.

Regulators should continue to permit merchants to do so. A clear delineation of the regulatory and legal responsibilities between a PSP and the financial institution supplying its accounts is necessary. To allow new entrants to introduce services without creating incentives for financial institutions to thwart these efforts, it is important that PSPs and financial institutions understand their responsibilities and liabilities and that those responsibilities and liabilities are appropriately allocated. This higher level of capital and liquidity means that Canada is well positioned to meet the higher capital and liquidity standards adopted under the Basel III framework.

The IMF points out that Canadian banks have been more resilient, because Canada has a strong financial regulatory and supervisory framework. The regulatory structure also discourages Canadian banks from taking excessive risks. Canada requires banks to hold capital at rates that are higher than those set in the Basel Accords. Canadian banks reported record profits in , as greater income from fees and wealth management and costs compression have more than offset narrower interest rate margins from the slower growth in household loans.

Imbalances in the Canadian housing market. House prices are still growing faster than disposable income as shown in Table 2. Elevated level of Canadian household indebtedness. The ratio of aggregate household debt to disposable income in Canada remains at a historically high level, as shown in Table 3. Significant exposures to potential external shocks.

Canada is an open economy, which means that its markets for goods, services and finance are globally integrated. While access to global markets provides important benefits to Canadian households, businesses and governments, cross-border linkages can also transmit external vulnerabilities and shocks to Canada. PAN E. User name Password Remember me Forgot your password? Forgot your username? Create account. Department of Finance Responsible for the legislative framework governing banks and other federally regulated financial institutions in Canada. Financial Institutions Supervisory Committee FISC A committee of senior government representatives who meet regularly to share information and advise the federal government on financial system issues.



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