Passporting of E-money Institutions

1.   Exchanging units of value and the develoment of ‘money’

Electronic money, notwithstanding the fancy name, bears strikingly similar functionality to the paper and coin money we are all familiar with.  Therefore before I proceed with explaining the concept of E-money, European E-money Institutions (hereafter referred to as ‘EMIs’), and the legal framework permitting the passporting of these institutions inter-EU states, I will first elucidate some reasons for the use of ‘money’ as a means of payment.  Incidentally ‘E-money Institutions’ merely refers to those entities which are authorised to issue e-money lawfully, however, I shall return to this point later.     

As a rule, the paper notes and metal coins which we use as ‘money’ hold a low intrinsic value.  Nevertheless, they act as a token representing greater value.  The credit institution[1] on issuing these tokens gives rise to a claim in favour of their bearer which the institution undertakes to make good up to a pre-determined value.  This value is imprinted on the token and denoted in monetary terms. 

One can observe that a credit institution would issue the tokens in a selective manner.  Namely, they are issued in favour of persons holding an account with the banking institution in question in lieu of the value which those persons have deposited with the bank. 

2.   What is ‘electronic money’?

E-money functions on the same principle and serves an analogous function to paper and coin money.  An institution issues (e-money) tokens[2] of low intrinsic value to particular individuals.  The claim in question is for a pre-determined value, higher than the intrinsic value of the token, which the issuer undertakes to make good up to the same pre-determined value.  Similar to the deposits of persons in a credit institution, e-money is issued in lieu of a pre-paid value (money) by the bearer of the e-money token to the credit of the issuer. 

Consequently the value of the claim is customarily denoted in monetary terms, however, the transfer of value is by e-money which marks it apart from debit and credit cards where token money is transferred from say the buyers account to the sellers account. [3]  Finally, in order to be considered ‘e-money’ the token should be accepted as a means of payment by a party other than the issuer.[4]

3.   Regulation of EMIs in Malta

Notwithstanding the close similarities between the two payment systems, the Second E-Money Directive (hereafter referred to as ‘2EMD’),[5] which regulates the issue of e-money, considers that e-money need not be issued by only credit institutions.[6]  An EMI may be used as an alternative when the specific task of issuing e-money only is required.[7]

The Malta Financial Institutions Act, which supplemented by subsidiary legislation[8] and the MFSA’s Financial Institutions Rules (hereafter referred to as ‘FIRs’), transposes the provisions of 2EMD.[9]  EMIs are classified in the Act under the umbrella term ‘Financial Institutions’.[10]  This is distinct from credit institutions, which are authorised under the Malta Banking Act 1994.[11]  As explained the activities of financial institutions and credit institutions may be similar in nature.  However, the Act specifies that as the point of demarcation between the two, a financial institution may not raise funds by taking ‘deposits’[12] or other funds from the general public.[13]  Of course a credit institution, a bank, can so raise funds.

This marks a point of diversion from the First E-Money Directive (hereafter referred to as ‘1EMD’),[14] which permitted the functions of EMI to be conducted only by credit institutions on account of the stringent prudential and compliance requirements they are subject to.[15]  The immediate benefit is that less stringent requirements apply to financial institutions.  In theory at least this should promote their popularity.  However, in parallel with the establishment of ‘stand-alone’ EMIs introduced by the 2EMD, EMIs were also made subject to prudential and supervisory rules as with credit institutions, albeit of a nature which reflects the formers business. 

It should be noted that under the Act varying levels of prudential supervision rules apply according to the type of financial institution in question.  For the purpose of this paper, I shall focus on the rules applicable to financial institutions acting as EMIs which issue electronic money only.[16]    

4.   Authorisation as a pre-requisite to operating as an EMI

An EMI may only issue electronic money in and/or from Malta if firstly it operates through a company and secondly if it possesses a valid licence to perform this function by the competent authority.  In terms of the Act[17] the competent authority is the Malta Financial Services Authority (hereafter referred to as the ‘MFSA’).[18]

4.1. Prudential supervision of an EMI

The Act provides that the MFSA should only authorise an entity to issue electronic money after it has ascertained that the applicant will conduct this activity in a prudent manner.[19]  In this regard an applicant should abide by a number of pre-conditions in order to receive a licence under the Act.[20]  The MFSA has issued FIR/01 which elucidates the pre-conditions for the granting of a licence.[21]

In brief, the following are some of the preconditions which apply to the applicant:-

1. Initial capital of not less than €350,000;[22]
2. The entity must have at least 2 directors;[23]
3. All persons directing the business must pass a fit and proper test;[24]
4. A clear and sound business plan;[25]
5. Effective supervision of the entity can be maintained by the MFSA at all times throughout the duration of the licence.[26]

A significant number of other requirements are established by FIR/01 which should accompany an application form for a licence under the Act.[27]  I reiterate my point that the preconditions serve to ensure the responsible and prudent holding of a licence and subsequent conduct of business by an EMI.

4.2. Ongoing prudential supervision of EMIs

Subsequent to the issue of a licence, ongoing regulatory requirements contingent for the maintenance of a licence under the Act apply.[28]  These include the regulation the activities which an EMI may carry out, updated compliance conditions, ‘own funds’ requirements and other.  The MFSA has issued FIR/03/2011 in this regard which lists certain specific provisions on post-licensing prudential and compliance requirements.[29]

EMIs authorised under the Act are expected to hold own funds calculated according to “Method D” of 2EMD.[30]  Accordingly, an EMIs own funds shall amount to at least 2% of the average outstanding electronic money.[31]  Moreover, the Act envisages that EMIs also observe the rules on own funds applicable to credit institutions.[32]

On the basis of an evaluation by the MFSA of the entity’s risk-management processes, risk loss databases and internal control mechanisms, the MFSA may order a amendment of the own funds requirements to 20% higher or 20% lower than the amount of own funds which is obtained using the calculation in terms of ‘Method D’.

4.3. Waiving the requirements of prudential supervision of EMIs

The 2EMD contemplates that local authorities in each EU MS may waive the application of all or part of the above prudential and compliance requirements in relation to EMIs.[33]  The MFSA is authorised under the Act to waive the application of part of the prudential and compliance requirements as set out in the Act and FIRs during the application for a licence under the Act and there after. 

However, this exemption is envisaged in relation to ‘small electronic money issuers’ only.  That is EMIs in relation to which:

1. the total business activities of the EMI generates an average outstanding electronic money of less than €2,000,000;
2. none of the natural persons responsible for the management or operation of the EMI’s business has been convicted of offences relating to money laundering or terrorist financing or other financial crimes;[34]
3.  
4. the payment instrument of the consumer where the electronic money is stored does not exceed €250 in value.[35]

The effect of the waiver is to grant a number of derogations from the preconditions referred to in point 3.1 above.  Therefore an entity satisfying the three requirements above is still subject to prudential supervision, initial capital, own funds and safeguarding requirements.  However, this supervision is applied less stringently at the discretion of the MFSA.[36]  For instance, the initial capital requirement of a small electronic money issuer availing itself of this waiver is of €50,000 to €100,000, rather than €350,000 as held in point 3.2 above.[37]

5.   A Malta EMI passporting its activity to another Member State

The effect of the standards imposed by 2EMD across all EU and EEA member states (hereafter referred to as ‘MS’) is that as a general rule, an EMI licensed in one MS may issue electronic money in any other MS without requiring to obtain a (another) licence and satisfy the prudential supervision rules imposed by the second MS.[38]  In the case of a Malta EMI wishing to so ‘passport’ the issue of electronic money in MS, it should inform the MFSA of:-

1. its intention to passport its services,
2. the identity of the second MS;
3. the name of the Malta EMI and its head office address;
4. the activities which the Malta EMI intends to perform in the second MS.[39]

Furthermore, where the operation shall be passported by the opening of a branch in the foreign MS it should inform the MFSA of:

1. the name of the MS in which it intends to establish a branch;[40]
2. the name and address of the head office of the Malta EMI;[41]
3. the activities which the Malta EMI intends to carry out in the MS;[42]
4. the address of the proposed branch;[43]
5. the names of those responsible for the management of the proposed branch;[44] and
6. the organisational structure of the proposed branch.[45]

The MFSA shall transmit the said information to the relevant authorities in the second MS within a month of receiving them.[46]  The foreign authority, having received this information, will communicate this point with the MFSA, enabling the Malta EMI to passport its activities into the foreign territory.[47]  In the event that a branch shall be established, the MFSA would accordingly register the branch.[48]

6.   Prohibition from passporting the activity of an EMI to another MS

Directive 2000/46/EC,[49] which was the predecessor of the 2EMD, had established that an EMI which is exempted from the prudential framework established by EU law, would be prohibited from passporting its services beyond its home MS, that is, beyond the territory of the MS which granted the exemption.[50]

This prohibition is one of the tenets of the 2EMD.  In fact recital 16 thereof specifies that; ‘(...) institutions benefiting from such a waiver[51] should not have the right under this Directive[52] to exercise the freedom of establishment or the freedom to provide services and they should not indirectly exercise those rights (...)’.[53]

As explained above, the Act does envisage such a waiver in favour of small electronic money issuers in terms of point 3.4 above.[54]  While the Act and the Rules do not transpose the corresponding prohibition to passport, it is established in terms of FIR/03/2011 which provides that; ‘An electronic money institution, to the exclusion of a small electronic money issuer, may exercise a European right to issue electronic money in another Member State or EEA State (...).’[55] (emphasis added)

7.   Passporting of European EMIs into Malta

In a similar fashion to the passport of Malta EMIs’ services out of Malta, foreign EMIs may passport their services and issue electronic money in Malta either through the establishment of a branch or under the freedom to provide services into Malta.[56]  On satisfying the conditions below, there is therefore no requirement to obtain a licence under the Act and satisfy the prudential supervision rules imposed by the Act, the Rules and FIRs.

Where a foreign licensed EMI wishes to issue electronic money in Malta it should communicate the following information to its home regulatory authority:

1. its intention to passport its activities to Malta;
2. the name and the head office address of the electronic money institution;
3. the activities it intends to provide;[57]

Furthermore, where the operation shall be passported by the opening of a branch in Malta, the foreign EMI should inform its home regulatory authority of:

1. the nature of the services which will be carried out;[58]
2. the name and address of the head office of the foreign EMI;[59]
3. the address of the proposed branch;[60]
4. the names of those responsible for the management of the proposed branch;[61] and
5. the organisational structure of the proposed branch.[62]

The foreign authority once in possession of the above information should tender it to the MFSA within one month of its receipt.[63]  Upon the foreign regulatory authority informing the foreign EMI that this information was transferred to the MFSA, it may commence activities in Malta.[64] In the event that the foreign EMI wishes to set up a branch in Malta, the foreign regulatory authority may proceed to register a branch on the lapse of one month from the receipt of this information by the MFSA.[65]

[1] Commonly known as ‘banks’.

^[2] This generally adopts a card of computer software format.

^[3] ECB, Electronic money Institutions, Current Trends Regulatory Issues and Future Prospects, (July 2008, 11 – 12.