As technology advances and financial services are increasingly digitalized, opportunities for identity theft and money laundering continue to rise. To combat this, banks and money transfer companies are subject to “Know Your Customer” (KYC) policies. In brief, Know Your Customer is the process of verifying the true identity of your client. KYC policies were enacted in order to prevent money laundering, terrorist funding, financial fraud, and identity theft.
Australia, The United States and The United Kingdom have similar KYC policies. The following customer information must be verified and confirmed before money transfers can take place:
Australia, the US and the UK each have varying policies regarding what is acceptable proof of identification, though all require unexpired government issued documents, such as passports or driving licenses as one of the supporting documents.
In addition to KYC obligations, new challengers and other providers in the UK are also regulated by the new Payment System Regulator (PSR) which began operating on 1 April 2015. The PSR oversees most of the payment industry in the UK, and is intended to promote competition, innovation, and ensure any new industry developments benefit the end-users. While this introduces yet another regulatory body for new challengers to navigate through, it may also benefit smaller companies. One of the signature goals of the PSR is to make payment system operators (such as the networks behind BACS and Chaps interbank systems) more transparent so that smaller players in the industry can meet access requirements.
Transfer companies also need to be aware of the looming Markets in Financial Instruments Derivatives (MiFID) II rules, which are set to come into effect on 3 January 2018. While MiFID II has been in the works since 2014, the exact details and requirements are only now being published and enacted. The new regulations are wide-ranging, and designed to more closely regulator risk within the entire financial sector. Although some of the main portions focus on derivatives and post-trade transparency requirements, navigating the new rules and disclosure requirements will almost certainly add to money transfer companies’ compliance and regulatory costs.
By Cameron Graham, Ian Manns, Andrea Barnes | October 11th, 2016
Challenge: How will much will the costs of adhering to MiFID II regulations stifle growth and innovation in the market?
As a result of KYC rules and increasing financial sector regulations, some banks now see money transfer companies and their accounts as a potential regulatory risk. Because money transfer companies interact with hundreds or thousands of different customers, having an open account for them in effect exposes a bank to hundreds of extra channels – all of which may be monitored by government regulators.
This means banks need to ensure that transfer providers are operating within KYC guidelines, and are not violating any terrorist financing or anti-money laundering (AML) regulation – even if unintentionally. Even though the transfer provider is facilitating such transactions, banks can also be held liabilite for providing the infrastructure and accounts. The consequences can be expensive, and have led some banks to undertake large “de-risking” measures.
In 2012, global bank HSBC agreed to a USD 1.9bn settlement with the US government over alleged negligence in AML practices. In November of 2012, after giving a 30-day notice to their customers, HSBC proceeded to close the accounts of all money transfer providers on its network. In May 2013, Barclays followed suit, closing the accounts of 250 money transfer providers due to noncompliance with AML regulations.
Starting in 2014, Australian banks began to encounter similar issues. Between 2014 and 2015, AUSTRAC (Australian Transactions Reports and Analysis Center) reports at least 719 money transfer provider’s accounts were closed. In explaining such decisions, Australian banks primarily cited reputation, fines and international regulations as the reasoning. Westpac bank, in particular, closed every single money transfer account, after a 30-day notice period.
The decisions by HSBC, Barclays, and many Australian banks represent one of the larger threats to new money transfer providers. As global financial regulations continue to increase, more banks may decide to minimize their risk by cancelling most or all transfer provider accounts.
So far, however, bank’s de-risking efforts have primarily hurt smaller transfer agents and phone-based brokers. According to data from the Financial Conduct Authority (FCA) which oversees the UK’s financial sector, 731 money transfer providers have had their operating licenses cancelled since 2010. Of these closures, 94.5% have been of “Small Payment Institutions,” while just 5.5% were “Authorised Payment Institutions.”
Challenge: Will the banking sector be prepared to support the growth and share the risk of the non-bank providers?
Such data suggests new challengers may be struggling to fulfill current regulatory requirements, or simply need to invest more time and resources into compliance. So far these closures and the general de-risking trend among banks has primarily affected smaller, phone-based transfer providers. These brokers typically serve a limited number of niche corridors, and have highly targeted customer-base of migrants. Larger companies, such as Ria Financial or HiFX, along with the majority of technology-based new challengers have remained open throughout such changes however. This is possibly due to such companies access to venture capital which can be channeled into compliance measures, and the relative ease of tracking internet and app based payments versus phone and in-person transfers.
One of the challenges for new transfer companies seeking to transition into established players is the need for brand recognition among consumers. While new services have effectively used advertising and stunt campaigns to generate media exposure and social media attention, they are competing with brands that have spent decades building brand awareness. In addition, money transfer services are a specialized financial product used by only a small fraction of the population compared to mainstream products such as bank accounts, credit cards, and loans. This provides additional marketing challenges, as traditional large-scale tactics such as televisions advertisements tend not to be an efficient way to reach potential users.
According to data from a 2016 survey by FXcompared Intelligence, 87% of UK consumers had heard of Western Union, while just 15% of respondents had heard of Transferwise. In the U.S., the discrepancy is even more lopsided. 94% of U.S. consumers are familiar with Western Union, while only 13% are familiar with TransferWise. Other challenger companies such as Remitly and WorldRemit fair even worse, with just 12 and 10 percent of consumers, respectively, having heard of or used them. Such stats shows the enormous challenge new companies face in building a trusted financial services brand.
A potential advantage for new challengers however is their embrace and understanding of digital services. Looking at internet reviews, an increasingly common measure of consumer trust, it is obvious new challengers have been more adept at securing positive reviews and promoting themselves through this medium than traditional providers.
For instance, despite Transferwise’s much smaller customer base and marketing budget, they have over 29,500 reviews on online rating site TrustPilot, along with an “Excellent” 9 out of 10 rating, compared to Western Union’s 781 reviews and 8.2 rating. MoneyGram and MoneyCorp have just 36 and 25 reviews, respectively, along with scores of 1.7 and 4.2.
While the scores themselves may or may not accurately reflect each brands’ services, the number of reviews suggests traditional providers have not made a concerted effort to secure ratings from their customers. In part, this may be due to the split nature of such services – while Western Union has an app and online presence through which it can ask for positive ratings, many of its customers also use its service via storefronts and physical locations. Online-only services meanwhile can push every customer to leave a review. This digital advantage may give new challengers an edge in building brand awareness and reputation among internet-savvy and younger consumers.
Marketing has become a key tactic for new entrants in the money transfer space looking to expand their brand and rapidly scale their customer base. While banks and traditional money transfer services were able to rely on their ubiquity and in many cases monopoly over payment infrastructure for much of the industry’s’ history, internet companies have leaned heavily on targeted, aggressive campaigns to raise awareness about alternative transfer options. PayPal was one of the originators of such unorthodox tactics. In order to convince people to try its service, it initially offered a USD 10 payment to anyone who created a free account - along with additional payments for those who recruited friends to join the platform. Many of today’s new entrants have followed a similar playbook - Remitly for instance operates Remitly Rewards in which users can receive giftcards in exchange for referring new members. New challengers have also exploited their status as under-dog competitors, with ad campaigns designed to create free publicity (and social media attention) and underscore the difference between them and their “traditional” peers, such as TransferWise’s public flash mobs in central London.
Despite increased competition in the marketplace and the aggressive marketing efforts of new startups however, most traditional players do not yet appear to be responding in kind. Western Union’s last major global marketing campaign finished in 2009, and their annual marketing spend has since declined by approximately USD 3m. For the last two years it has remained flat at USD 210m globally.MoneyGram, another major traditional service, shows a similar pattern of relatively stable marketing expenses. Since 2007, their marketing budget has increased by only USD 2.9m, from USD 56.5m to USD 59.4m in 2015.
Challenge: Will new challengers be able to raise enough funding to establish themselves as financial brands and compete for customers against traditional providers?
One reason for this may be the size of such company’s marketing budgets to begin with. Compared to even mid-sized players such as Xoom (prior to PayPal’s recent acquisition), the average annual spend of Western Union and MoneyGram remains formidable. Between 2007 and 2014, Xoom increased their marketing budget by over sixfold, from USD 5.8 million to USD 32.7 million. Yet that represented barely more than 15% of Western Union’s total spend for the year, and half of MoneyGram’s budget.
Similarly, while the latest startups have made marketing a key priority, they remain far behind major traditional services in terms of overall spend. This is likely why new challengers have leaned heavily on public PR stunts (such as Transferwise’s central London flash-mobs) and aggressive messaging designed to create controversy.
According to the latest figures released by Transferwise, their marketing expenses totalled approximately USD 12.4 million in 2015 and USD 16 million for the year ending March 2016. This is a much smaller sum than any current market leader. It should be noted however that, as Transferwise is still quickly expanding its global operations, it is possible this number may rise significantly in the coming years, as the company enters additional markets.
Banks meanwhile have not made any significant effort to defend their position in the money transfer space. This is likely because of the high costs of operating in the space (due to KYC and AML regulations), a recent shift towards wealth management and security services within the banking industry, and a lack of desire to invest resources in an industry with shrinking margins. Also, unlike traditional services and digital transfer companies, banks are not reliant on maintaining a competitive money transfer service in order to attract or retain customers. This means they face far less pressure to advertise within the space, or build brand awareness for such services.
Open, blockchain-based digital ledgers represent a new way to conceptualize and track international transfers and payments. Most transfer startups (aside from mobile-only operators such as M-Pesa), rely on traditional banking infrastructure on both ends of a payment. Money is withdrawn from a consumer's account (either by the consumer or directly by the service), then transferred into another account somewhere else in the world. In order to keep track of such payments, banks have traditionally used a system of double-entry bookkeeping, a bedrock principle of modern accounting. A blockchain-based ledger would replace this system of bookkeeping with an open-source, publicly accessible payment log that could be inspected and verified by anyone with an internet connection. Transactions would be logged without the need for any manual supervision or reconciliation - potentially eliminating an entire class of financial service jobs. Paired with a reliable digital currency, blockchain technology could provide a way to bypass traditional payment structures and banking networks altogether.
More so than current startups that undercut banks and traditional providers on transfer fees and exchange rate spreads, the blockchain represents a more radical rethinking of payment networks and how money transfers work. However, given the intensity of regulations surrounding international money transfers and remittance payments - whether in the form of KYC or AML laws - it is unlikely that an entirely distributed, potentially anonymous payment network will emerge in the near future, regardless of the technical feasibility. Concerns over fraud are another potential roadblock to widespread adoption.
Still, numerous banks have begun to experiment with the technology, including major FX players such as HSBC and Goldman Sachs. Santander has gone so far as to begin conducting a trial run among employees of a new blockchain based money transfer app. How they, and other banks incorporate such initiatives into their existing infrastructure, and how governments choose to regulate the technology will likely determine exactly how revolutionary the blockchain will be.
Challenge: Can a nascent technology with a troubled history become a mainstream backbone of international payments? Will blockchain be able to overcome regulatory and governmental scrutiny?
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