common ground

 Payments Aggregation

by Greg Cohen

    After years of keeping settlement funds out of the hands of third parties, here come the Aggregators!
   In the early days of payment processing, settlement funds aggregation was a normal business practice. Larger merchants would often take credit cards on behalf of smaller merchants and ISOs would remit settlement funds to their merchants after getting mass funding from acquiring financial institutions. However, after the implosion of an ISO and a merchant or two, the financial and reputational risks to the networks and the payments ecosystem were deemed to be too great for the card brands. The potential for merchants to not get funded became apparent and the card brands devised rules mandating that only financial institutions (acquirers) be able to manage merchant settlement funds. The networks fought tooth and nail through the years to keep funds out of the hands of any entity other than a financial institution in order to maintain the “integrity of the payments system.” Oh – but the times are changing.
   As the Internet came along there was tremendous pressure applied on the brands to allow for Internet aggregation and rules for Internet Service Providers (IPSP) were developed. The most successful of these IPSPs is PayPal but many others exist often catering to very narrowly defined market segments including some higher-risk markets. The rules were originally developed to provide small ecommerce merchants a way to cost-effectively accept payments. The IPSP regulations allowed for internet transactions to be aggregated by master merchants who would then fund smaller (under $100,000 per year) Internet (sub) merchants. As many acquirers learned, there is significant risk in boarding IPSPs that do not have a good foundation in risk management. The risk lies not just in the stability of the actual IPSP merchant but fraud potentially perpetrated by any sub-merchant. The ability for sub-merchants to morph business models, commit fraud and expose the IPSP and ISO/acquirer to significant financial exposure and fines is great. Sub-merchants are often not monitored as closely as traditional merchant accounts and without proper controls can create tremendous liability. I have personally been involved with an IPSP that had a sub-merchant that morphed from selling vitamins to bogus coupon books in a matter of days and created potential exposure of more than $10 million for the acquirer. More recently, an IPSP boarded a sub-merchant that started accepting payments for adult web-sites and cost the acquirer hundreds of thousands of dollars in fines.
   With the brands now public and looking to not only drive incremental revenue through new transactions but create a preference for traditional brands over alternative payments Visa, MasterCard and Discover will now be opening up the aggregator model to the card present (retail) environment. Known now as the Payment Service Providers (Visa and Discover) or Payment Facilitators (MasterCard), the brands will be looking to drive incremental transactions from micro-merchants using third-party aggregators. This has brought an onslaught of new entities looking to enter this market quickly and grab market share. The attraction to the micro-merchant is similar to the legacy IPSP attraction; simplicity in activation and pricing as well as a pay-as-you-go model with none of the monthly fees you would see in a traditional merchant account. Square, Pay Anywhere and others are aggressively entering the market looking to build mass acceptance. Square claims to be deploying and activating tens of thousands of swipe units and merchants monthly. However, they have not disclosed the amount of transactions actually being conducted by these merchants. The business model may evolve but without a doubt we will see an onslaught of new Payment Service Providers (PSPs).
   We should expect to see many new competitors in both the online and offline aggregator business. These new competitors (they are signing up merchants after all) do create risks to the entire payments infrastructure. Losses are real and, without tight controls in place, future delivery risk and fraud could be a major concern. It will be interesting to watch what could happen if a PSP goes defunct and thousands of merchants do not get their settlement funds. With the brands now public entities and not bank-owned associations the need for transaction and revenue growth is obviously paramount. They have opened up the sacred world of “access to settlement funds,” a taboo just a few years back, and put the onus of management and monitoring of these PSPs on the sponsoring financial institutions. Developing a PSP business model or boarding PSPs is scary business. If you do venture towards aggregation make sure both the PSP and your internal risk controls are set to manage these micro sub-merchants that often change business models overnight.
   After years of keeping settlement funds out of the hands of third parties, the brands have changed course. We should expect to see aggregators entering the payment space in emerging segments, verticals and distribution channels. They pose both an opportunity and a threat to existing players and the ecosystem as a whole. If managed properly there is market share to be grabbed. If managed improperly, losses and exposure could be tremendous. The aggregator model is a model we will all need to understand, eventually embrace and even compete against as the industry evolves.