WHITE PAPER August 2015 For professional investors

Fintech The Robin Hood of payments?

Jeroen van Oerle

Patrick Lemmens

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TABLE OF CONTENTS

Executive summary 2

Introduction 4

Technological trends 6

Regulatory trends 13

Socio-demographic trends 17

Summing it all up: winners and losers 21

Appendix A: Players in the ecosystem and their role 22

Appendix B: Payment fees and flows 24

Appendix C: Millennials adopt mobile phones fast 25

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Executive summary

Fintech: the Robin Hood of Payments?

The music sector has been re-shuffled by technology, Airbnb checked

into the hospitality service sector and the most striking technological

disruption is perhaps the drive-by shooting of Uber on the taxi-

branch. In sum you could argue that these industries have been

‘robin-hooded’ by technology companies. The idea is simple;

whenever margins are high, customers are unhappy and incumbents

are not changing to what their clients want, a tech company comes in

and takes over. Is the payment sector next? We believe certain

financial industries are indeed next on the list of technological

disruption. However, it is not the entire ecosystem that will be

disrupted! The value chain is becoming more fragmented and one

thing is for sure; the Fintech Robin Hood is putting pressure on

margins and incumbent’s profit models.

Technology, regulation and socio-demographics are shaping the payment system

The future of payments is being shaped by three factors, namely technology, regulation

and socio-demographics. Within these three broad drivers we have identified trends that

are either transformative or disruptive in nature. Although we do not think the payments

ecosystem as a whole will undergo revolutionary change, we see a clear direction into

which the three forces are pushing the ecosystem. The new name of the game is cheaper,

faster and more secure transactions.

Winners It is hard to pinpoint clear winners in every part of the ecosystem at this point in time. The

technology and/or business model that can disrupt has not yet gained the mass adoption

to actually be disruptive. There is one segment, however, where we think we can identify

winners, which is the networks. We think global network players like Visa Federation (Visa

and Visa Europe) as well as MasterCard are clear winners. Also networks that have found

their unique niche, like American Express and Alipay, are in our view winners. Despite the

fact that there have been many attempts in the past to replace networks, none of those

attempts succeeded. Trust and scale are very important for networks and the barriers to

entry are continuously increasing. Technological innovations within networks are

sustaining in nature. Disruptive technology in other parts of the ecosystem cooperates with

the current network players instead of disrupting them. From a regulatory perspective the

barriers to entry also increase due to decreasing interchange fees and increasing safety

requirements.

Losers The frameworks that we use to evaluate the impact of technological innovation are more

suitable to find challenged industries than winners. We think card issuers, payment card

producers (chips) and point-of-sale hardware providers are challenged by new technology.

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The introduction of mobile payment solutions will have consequences for point-of-sale

(pos) hardware providers. From a regulatory perspective issuers and card manufacturers

are challenged as well. Issuers’ business models will be greatly impacted by the

implementation of the payment service directive 2 (PSD2) that cuts interchange fee

incomes of issuers. Card producers are compelled to comply with the latest standards

which cost a lot of money and cannot be priced on to customers while at the same time

(cheaper) digital alternatives become available.

Figure 1. The payment ecosystem: winning and challenged industries

Source: Robeco

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Introduction

Disruption or sustaining innovation?

Financial technology, a.k.a. fintech, has gained popularity as a topic

of debate and has become the quintessence of transformation in the

financial sector. To some, fintech will do to payments what tech did in

other sectors; namely disrupt existing industries. To others, fintech is

just an assembly of companies that are able to avoid regulation and

thereby manage to offer services at lower prices during the limited

time period in which they can take advantage of this regulatory void.

We think there is truth in both statements, but these are obviously extremes. We define

technological disruption in the Christensen framework1. Technological progress is only

disruptive if it serves a new set of customers that has a different measure of performance

compared to the old technology. Best example has been digital photography. This

technology was far from superior to chemical photography in terms of photo quality, but it

performed well on other performance measures such as the ability to instantly see the

result as well as the larger number of photos that could be taken without the need to

purchase film. Over time, digital photo quality improved which enabled mass adoption

and completely disrupted the photo industry.

Not all parts of the payment ecosystem are equally impacted by fintech

The payment ecosystem is very large and complex, as figure 2 shows. In this whitepaper

we will identify which parts of the payment ecosystem are at risk of being disrupted and in

which parts we see no case for disruption but rather believe in sustaining innovation. Next

to technology, we will also describe regulatory and socio-demographic trends that

influence payments. We will zoom in and specify which trend will impact which specific

part of the industry. Contrary to what is often claimed, fintech will not disrupt the entire

industry and there is not one specific fintech solution that influences the total payment

ecosystem. The payment value chain becomes more fragmented though by the large

number of fintech companies entering the industry.

1 Clayton Christensen, “The innovator’s dilemma” (1997)

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Figure 2. The payments ecosystem

Source: Payfirma

Fintech is the Robin Hood of the financial sector

When looking at the impact of technology in sectors like entertainment, hospitality

services and the taxi branch we can conclude that they all had one common outcome

which can be summarized as the Robin Hood effect. By that we mean that a large part of

the economics of the goods or services offered is returned to customers, who also become

more empowered. This is accomplished by introducing a very high level of transparency

through the usage of data and technology. The choice parameters of consumers change or

expand and the performance metrics they used in the ‘old’ world are no longer valid. We

believe the introduction of fintech will also change consumers’ performance parameters in

payments. The long run consequence will, in our view, be a Robin Hood effect.

Technology, regulation and socio-demographics: the building blocks of trends

Although the discussion on disruption most often focuses on technology, there are other

factors impacting the payment ecosystem. We define three main forces that shape

payments, i.e. technology, regulation and (socio) demographics. Rather than simply

explaining all technological trends that are playing out in payments, we structure the

discussion with the help of Clayton Christensen’s disruptive technology framework. We

combine this model with the chasm theory of Geoffrey A. Moore2. We will analyze the key

sub-sectors of the payment ecosystem and determine whether they are disrupted, in which

case it is wise to look at newcomers, or displaying incremental sustained progress, in

which case it is advised to stick with incumbents. Next to technology we will discuss

regulatory changes and trends which we again narrow down to a discussion in terms of

sub-industries that will benefit and lose. Finally we look at socio-demographic impacts on

the payment ecosystem. The way we pay differs per region as well as per generation.

2 Geoffrey A. Moore, “Crossing the chasm” (2006)

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Technological trends

Technologies such as near field communication (NFC), beacons, blue-

tooth-low energy (BLE), mobile payments and payment dongles with

facial recognition all have a sci-fi level that appeals to some and is

despised by others.

As discussed in the introduction, we look at technological trends by combining the

frameworks of Clayton Christensen which discusses technological disruption and Geoffrey

A. Moore which discusses the process of new technology trying to reach a critical mass

before being generally accepted. It is important to remember that technology will not

disintermediate the entire payment ecosystem as often preached in opinion papers. New

technologies have a clear focus on specific sub-industries within payments and only a few

actually disintermediate. Most technologies actually cooperate with certain parts of the

ecosystem and tap into new profit opportunities in other parts. We discuss the

technological trends that we believe will have the most profound impact on the sector,

and we eventually lay out which sub-industries are most likely to benefit and which are

challenged.

Stay with incumbents when technological innovation is sustaining, go for challengers when it is disruptive

Clayton Christensen theorizes the impact of technological change on an industry by

identifying which customer group is being served and which performance indicator is most

important to this customer group. Over time, customers increase their expectations

regarding performance as shown in figure 3.

Figure 3. Theorizing technological change

Source: C. Christensen, G.A. Moore, Robeco

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The first mobile phone would probably be defenestrated when in the hands of today’s

users because it doesn’t fit their performance standard anymore. However, there were

people who purchased the first mobile phones because, at that point in time, it did fit their

needs. If changes are incremental, they are on the sustaining innovation path. Efficient

innovation can be defined as technology that serves the same customer group on the

same performance metrics, but more efficiently, thereby saving costs or increasing

convenience/customer experience. In both sustaining and efficient innovation the

incumbents have the best chance of surviving because they have scale and efficiency which

allows them to implement the new technology and thereby serve their existing customers

the way they expect to be served.

Disruptive innovation is a new technology that targets a new customer base and is

evaluated on a different performance metric. Over time, however, this disruptive

technology can conquer the performance standard and attract customers from the ‘old’

technology. In case of disruptive innovation, the disrupters are more likely to win than

incumbents, but identifying clear winners is hard. Instead of focusing on winners, the

framework allows for better identification of losers.

Crossing the chasm is an essential step for new technology to survive Early adopters are happy to use new technology, even when it is not functioning optimally

yet. The most important customer group in terms of profit potential is not the early

adopter but rather the mass market. This is where the theory of Geoffrey A Moore comes

in. Before new technology can actually make the jump from the early adopters to the mass

market, it needs to ‘cross the chasm’. At this stage the technology, business model and

consumer proposition all have to come together to enable that jump. Potentially

disruptive technology can only become disruptive if it is able to close the performance gap

between different user groups. This is exactly where most start-ups and new technologies

fail.

Figure 4. Cash still dominant in both purchase volume and percentage of transactions

Source: CLSA, The Nilson Report, MasterCard

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Categorizing new technology to identify winners and losers As explained previously, if we know which technologies are sustaining innovation and

which are disruptive in nature, we know who the most likely winners and losers are in

terms of newcomers versus incumbents. We go through all three types of innovation

(sustaining, efficient and disruptive) and pinpoint what industries within the payment

ecosystem of figure 2 are on the sustaining innovation track and which are about to be

disruptive.

Sustaining innovation can be found in networks and large merchant acquirers

We think global networks (Visa, MasterCard) and large merchant acquirers (Vantiv, Global

Payments) are evolving in line with the sustaining innovation analogy of Christensen.

Security enhancements and infrastructure improvements require scale in order to be

economically attractive. Scale requires trust and low costs, which is lacking for many

newcomers. Technological innovation is mostly tailored to the same customer groups and

is evaluated within the same performance matrix. We think the customer base for

networks will increase further as we will see a continued shift away from cash, towards

card/mobile payments. As shown in figure 4, cash still represents 85% of global

transaction volume, so there is plenty of room to grow. As transaction volumes increase,

the global networks and processors will benefit.

Despite the many attempts to find alternative technology for networks, we believe the

importance of scale and trust has now come to a point where sustaining innovation will

prevail over the potential for disruption. The foundation for this statement comes from the

failures of, amongst others, Revolution money and Debit man as alternatives for

Visa/MasterCard. Even an initiative as MCX, which has support from a large group of

American merchants, is not likely to replace networks due to the lack of broader scale and

trust.

Within the merchant acquiring space we also believe the large acquirers benefit from scale

and trust in a way that is very hard for technology companies to disrupt. These companies

have the ability to be technology and platform agnostic, which is precisely what their

customers require. Although, from a technological perspective, there is no disruptive

element, we believe there will be continuous pressure on margins.

Figure 5. The number of non-cash transactions keeps growing; CEMEA grows fastest

Source: Robeco

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Efficiency innovation: block chain and real-time transactions Efficiency innovation most often leads to fewer jobs because the same work can be done

by a smaller amount of people. Blockchain technology introduced in the back-office in

order to settle transactions and keep track of money flows in real-time has the potential to

be the efficiency innovation in payments. In the case of blockchain there are no companies

we can immediately identify as winner, although companies such as Ripple Labs and

Earthport are investing in servicing this technology.

In the long run, the introduction of blockchain technology in payments is likely to reduce

the headcount and has potential for significant cost reductions at merchant acquirers and

networks. For processors, the introduction of blockchain could have a negative impact if

they are not able to offer transaction settlement via blockchain technology. In the worst

case scenario for processors, blockchain would make their services obsolete.

Real time transactions are another example of efficiency innovation. Companies such as

Ripple in the UK enable faster transaction settlement which can easily be implemented

throughout the payment sector. We think real time transactions are not a threat to

incumbents, but rather require cooperation. Unfortunately there are no listed companies

that can benefit from these efficiency innovations directly at this point in time.

Disruptive innovation can be traced back to mobile

We think mobile phones are the long awaited connection between the online and offline

world. These two have been developing separately from each other in the past. Online

players like PayPal have thus far not been able to gain ground in the offline world and vice

versa with Ingenico and Verifone not gaining ground online. Mobile has the potential to

change this by connecting online and offline. Mobile therefore serves a different customer

base which looks at different performance indicators. This qualifies mobile as a potentially

disruptive innovation. Although it will not be disruptive for the payment value chain itself

(cards are still connected to the mobile phone), it can be disruptive to several sub-sectors.

It is important to keep in mind that mobile payment has not yet crossed the chasm. The

potential use cases are plenty, but mass adoption is an essential next step that has not yet

been taken.

Mobile payment providers disrupt card issuers and pos providers Mobile payments fit the description of disruptive innovation.

The customer base has expanded and is no longer restricted

to card holders. Companies like Vodafone (M-Pesa) in

Kenia, but also Apple and Samsung/Android enable the

mobile phone to be used as a device that makes payments.

In countries where the infrastructure for card payments is

less developed, this enables a new customer group to join the payment ecosystem.

In the developed world, mobile payment technology will have to prove its value versus the

usage of cards. In its current stage, a mobile payment is not yet superior to a card payment

when it comes to security and customer experience. It does not materially differ if you take

out a card to make a payment, or your mobile phone. There is also a lack of trust with

respect to the security of mobile payments. However, this is typical for early stage

disruption. Gradually the performance matrix will start to shift and add capabilities. We

believe security of mobile payments will become superior to that of cards. We also think

mobile payments are able to increase the customer experience by means of aggregating

functions such as the actual payment itself, record keeping/warranties and reward

administration, and all at a lower cost than current solutions.

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Card makers are at risk If mobile becomes adopted by the mass market, card issuers might be at risk because

consumers’ willingness to pay for the physical card is reduced and competition from small

issuers that only offer virtual cards will have an impact on economics. Although the total

number of cards is still growing, the number of cards per person is decreasing. Recent

surveys already showed that the average number of cards has come down from more than

3.1 in 2008 to 2.6 in 2014 in the US3 and from 1.7 to 1.45 respectively in the EU4. The

main reason is cost related. The costs per card are increasing due to security requirements

and reduced interchange fees for banks which simply pass those costs on to customers.

Virtual cards are cheaper and might be a good alternative in the future. We also think

companies that provide secure chips such as Gemalto, Valid and Morpho (private) are

challenged.

Figure 6. Consumers using mobile phones to make payments in the last six months

Source: Innopay, Mobile Payments 2013: The Global Rise of Smartphonatics, AITE & ACI Worldwide

Mobile wallets may be disruptive, but the battle has yet to begin Mobile wallets are used to make payments via the mobile phone. Those payments can be

made at a physical point of sale or online. Mobile wallets are different from mobile

payment, which is the actual use of a mobile device to make a payment, whereas the

wallet is software. Mobile wallets are not necessarily disruptive as they can serve the same

customer base, but mobile payments have extended the number of use cases for mobile

wallets by offering payment solutions to those that have no cards and in some cases not

even have bank accounts.

Globally, only 55% of people have a bank account5. It is therefore not surprising to see that

the 45% unbanked show the largest usage of mobile payments, given the high level of

mobile phone penetration in those countries (see figure 6). There are many wallet

providers trying to build a customer base. We believe only a few will actually have the

potential to become mass adopted, but they need to prove to have value to consumers.

Those that combine hardware and wallets like Apple Pay and Android/Samsung Pay are

likely winners as well as those that have already reached critical mass like Alipay in China,

M-Pesa in Kenia and GCash in the Philippines. However, it is not unlikely that these

solutions ultimately get challenged if some ‘killer app’ is introduced that becomes mass-

adopted fast.

3 Gallup, 2015 4 ECB, 2015 5 World Bank, 2015

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As explained earlier, for disruptive innovations it is hard to pinpoint clear winners and we

should rather focus on losers. We believe wallets are a threat to card issuers and chip

producers, just like with mobile payment providers described above. However, wallets are

also a threat to wallets. There are simply too many providers and the performance matrix

has not yet been properly defined. The wallet should eventually be connected to a bank

account in order to really add value because customers require more than only a payment

tool. Currently none of the wallets has the essential scale, value or omnipresence.

The biggest disruptive threat comes from mobile point of sale providers…

Physical point of sale providers can be split into three groups, namely those that service

large merchants, mid-sized merchants and small merchants. Currently IBM and Cisco serve

large clients, Ingenico and Verifone serve mid-sized clients and to a lesser extent smaller

merchants, but there are still a lot of unserved small merchants.

Mpos focus in first instance on these unserved small clients. The performance matrix

consists of cost, book keeping and SKU (stock keeping unit) record keeping services. Once

the client base grows on the small merchants side, we believe mid-sized companies are

likely change to Mpos too. The current EMV (a security standard which is further discussed

under regulatory trends) upgrade cycle in the US came too early for Mpos to be mass-

adopted, but once the replacement cycle of the current pos terminals starts in about three

to four years, mass adoption is more likely.

Figure 7. Mobile point of sales penetration in the US

Source: BI Intelligence, NRF

…But competition is fierce

As can be seen in figure 8 the pos industry has become fragmented by the entry of mobile

offerings that all try to define their own niche. More than two hundred companies are

currently offering Mpos solutions. We believe that Mpos providers that are agnostic in

terms of technology- (NFC, BLE, QR, MST) and payment method (Apple, Android, Paypal,

Visa, MasterCard, credit, debit) have the highest chance of mass adoption. Declaring clear

winners is still too early, but we believe companies like Poynt, Square and Payleven are

well advanced on Mpos.

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In terms of companies that are challenged we think there is more visibility, with Ingenico,

Verifone and Pax Global at risk. In the short run these companies benefit from the EMV

liability shift in the US as well as the continued shift from cash to cards (especially in Asia),

but in the long run we believe they are less likely to serve their customers under the new

performance matrix with their current offering. These are hardware companies that now

have to offer software solutions. Even if these companies are able to keep market share in

mobile hardware, it is likely that it will lead to sales pressure and possibly margin pressure

given that the Mpos solutions are priced much cheaper than pos terminals. Although it is

not completely improbable that either of these companies can grow their position on the

software side, they have a legacy business that makes such crossing hard in comparison to

pure software competitors.

Figure 8. The POS pyramid after the fintech wave

Source: paymnts.com, 2015

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Regulatory trends

Regulatory changes have a big impact on future developments in the

payment ecosystem. Up until now we can define the direction of new

regulation as cheaper, faster and more secure and we think this will

continue. Cheaper is directed by the governmental limitation of

interchange fees. Faster is determined by new regulations in the EU

and is already implemented in the UK. More secure is established

through the implementation of the EMV standard. Almost every

country is implementing or preparing to implement regulation for

mobile payments. In this section we will look at the US, EU and China

to analyse the direction in which regulation is shaping the payment

ecosystem, because these regions have the biggest impact on fintech.

Figure 9. Worldwide EMV implementation for card present transactions

Source: Deutsche Bank ‘Mobile payments’, 2015

The US goes more secure through EMV

In most of the Western European countries the so called EMV standard (chip and pin) has

already been mandated. In Africa and the Middle East the standard has also become more

widely accepted and within Asia it is gaining traction in India and the ASEAN region. The

Chinese government has decided not to go for the EMV standard and rather adheres to the

so called PBOC3.0 standard.

It is interesting to see that in the US, the EMV standard has not yet gained mass

acceptance. Consequently, fraud loss in the US makes up roughly fifty percent of global

card fraud and amounts to over USD 7 billion per year6. This is about to change. As from

October 2015 onwards, there will be a so called liability shift in the US. If merchants have

not updated their payment terminals to adhere to the EMV standard, they become liable

in case of fraud. Within two years’ time, gas station vendors also need to comply with this

regulation. Cards as well as terminals still need to be updated because only 33 percent of

US terminals accept EMV payments currently. There is a big difference between tier-one

6 Business Insider, 2014

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merchants (top 200 retailers) and smaller merchants; EMV penetration at the former was

about 70% in 2014 versus low 20s at mid and small merchants. The liability shift has come

too soon for Mpos providers because that technology is not yet mass-accepted. The benefit

of the US EMV upgrade will likely go to companies such as Verifone and Ingenico. In the

long run, mobile payment providers will also benefit because the EMV upgrade also boosts

NFC adoption.

US interchange fee caps not likely to be implemented for credit transactions

The US was first to regulate interchange fees for debit transactions. These are the fees that

card issuers (often banks) receive from acquirers. They serve to incentivize issuers to

provide the cards to their customers. As part of the Dodd-Frank act in the US the

interchange fees were capped for debit transactions in the so called Durbin amendment.

Fees on debit transactions dropped by about 70% and are capped at USD 0.22 + 5bps of

transaction value. As a consequence debit rewards were capped and issuers actively

pushed customers into credit cards, which are not regulated. There has been a lot of

debate on interchange in the US, but we do not think credit interchange will be regulated.

EU wants cheaper and faster payments and a more competitive landscape

In the EU there is a move towards a Single Euro Payment Area (SEPA). One of the legal

foundations of SEPA is the so called Payment Service Directive 2 (PSD2). This directive

regulates, among other things, interchange fees and separation of card schemes and

processing entities. The directive was approved in June 2015 and will be implemented in

the EU from June 2016 onwards.

Figure 10. Interchange fee tiers in the European Union (selected countries)

Source: Robeco and European Commission, 2014

Interchange is being capped more aggressively in the EU In the EU the level of regulation is much higher than the previously discussed US rules.

Interchange fees for European transfers are capped for debit as well as credit transactions.

The debit interchange fees cannot be higher than 20 basis points of transaction value.

Member states can set lower fees for domestic debit transactions if they want. Credit

interchange fees will be capped at 30 basis points of transaction value. Commercial cards

and three-party schemes are excluded for the moment.

As can be seen in figure 10, the impact of this interchange reduction will be large across

European member states.

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On the debit side, a lot of countries are already applying a lower fee structure, but on

credit, the fee will come down significantly. The interchange fee caps apply to inter-EU

transactions. On a cross-border transaction, no caps are applied. Capping the interchange

fee in the EU is negative for issuers, but in our view the networks can benefit. Because

transactions are becoming cheaper, merchant acceptance for card payments is likely to

increase, which increases transaction volumes. What can currently be observed is that

countries with high interchange fees have fewer card transactions, so we expect these

countries to move up in terms of card usage once the fees are capped. There might be

pressure on the transaction fee itself for networks, but we believe increased volume will

more than compensate for that reduction.

Separation of card schemes/issuers and processing entities

The PSD2 directive also includes regulation for the separation of processing and issuing

activities. In many member states, there are still monopoly networks. France has “Cartes

Bancaires”, Italy has “Bancomat Mister Cash” and the European Union itself set up “EAPS”

for debit transactions.

By separating processing and issuing activities (and thereby opening up payments to all

cards versus scheme-member-only cards) there will be possibilities for global network

players like Visa and MasterCard to offer their processing services at a low price due to

their scale advantage. Currently, MasterCard is only processing 40% of its issued cards in

Europe. In contrast, many French and Italian issuers process 100% of their cards. We think

competition will increase which puts pressure on margins. Given the fact that scale is

essential, we qualify global networks as winners, with local networks and issuers being

challenged.

Figure 11. PSD2 opens up the doors to European payment services

Source: IX company, 2014

China is finally opening up, but it will take time for non-Chinese global brands to benefit China started to open up its card processing market in

October 2014, after the WTO had been pushing for it

since 2001. Before opening up, all transactions were

processed through the China UnionPay (CUP) network.

In 2014 CUP transactions processed USD 6.8tn worth of

purchase volume for debit and credit transactions (of USD 18.3tn worldwide). This market

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is now potentially opening up for MasterCard and Visa. Experts, however, do not expect

Visa and MasterCard to gain market share in the CUP dominated regions any time soon.

The first step seems to be co-operation between CUP and Visa/MasterCard (V/MA) in

which case V/MA issues the card, but CUP still routs the transaction (and receives the

transaction fee). In the long run, we believe V/MA will indeed find their way to benefit

from this regulatory change. In the short run, we believe CUP remains the dominant

network for Asia. In the coming years we expect to see more cooperation between Visa

and MasterCard and local wallets like Alipay and Tenpay in order to push adoption.

Although the regulator still favors the transaction infrastructure of CUP, V/MA are likely to

gradually take their piece of the China cake.

The Chinese potential will not be available to everyone Although global networks have now been allowed to conduct business in China, others still

need to find their way in. The government will probably regulate fintech more in the

future, as the influence of these companies grows. Especially in peer to peer transactions it

is already clear that the Chinese government keeps a close eye on developments.

Requirements for transaction/banking licenses are an example of this. We believe

domestic companies will always have an advantage in China over global companies, given

the importance for the government to control money flows. It is not unlikely though to see

strategic partnerships on key technologies.

Wrapping up the regulatory force

In conclusion we think there will be little impact from regulatory changes in the US.

Beyond the liability shift we see no reason for fee caps or other amendments to be

impelled. The EU is very active in opening up the domestic market and to make payments

cheaper and faster. We think the regulatory strain in the EU will be an important force in

the near future. It will in essence determine which companies have a business model that

is fit for this tough regulatory environment that is far from a level playing field. In China,

the main result of regulatory change is a further opening up of the market to foreign

companies. Although we see the Chinese regulator clearly moving into that direction, we

think the practical benefits to foreign businesses are limited for now.

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Socio-demographic trends

Socio-demographic trends are an important driving force in

payments. We would like to highlight two key topics. The first one is

the fundamental difference between developed and emerging

markets when it comes to payment methods and customer

preferences. The second topic is the difference between generational

payment preferences. Generations Y (Millennials) and Z make up

about 50-52% of the global population and are therefore an

important driving force behind changes in the performance metric.

Figure 12. Debit and credit usage differs per region…

… and is influenced by socio-demographics

Source: Goldman Sachs: The future of finance part 2, 2015

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Mobile payment technology in emerging markets means financial inclusion In many of the emerging markets, mobile payments have a completely different impact

than in developed countries. For almost 70% of the emerging market population, mobile

phones mean financial inclusion! Many people in emerging markets are not interesting to

banks due to their low income and/or lack of financial assets. For that reason many banks

have not invested in this customer group because they couldn’t make money on services

like payment cards, consumer loans, mortgages and insurance. In comparison, only 28%

of the US population is either unbanked (8%) or underbanked (20%).

Developed versus emerging, will the payment gap ever be closed? The introduction of a payment service by telecom operators dramatically changed the

scene for this excluded customer group in emerging markets. Although introduced

coincidentally and by the grace of the regulator, telecom operators fulfil a void in the

money transfer market in several African countries as well as in Latin America. There was a

need for money transfer services due to remittance flows. The introduction of M-Pesa in

Kenia for instance meant that every-one with a mobile phone (over 90% of the Kenyans)

was now able to also transfer money.

The telecoms have also tried to introduce payment services in developed countries, but it

has not been successful there, mainly because of regulatory differences. It seems that tech

companies and existing payment ecosystem companies are the best candidates to create

the use cases for mobile payments in developed markets, while telecoms and banks have

that advantage in emerging markets.

Legacy habits are hard to change As can be seen in figure 13, credit cards are the preferred transaction method in the US,

while debit is dominant in the EU and China. The American, Canadian and South Korean

customers are used to receiving rewards when they use their cards. Customer protection

through credit cards is much more advanced in these countries than through direct debit.

The combination of rewards and insurances lead to a strong preference for credit over

debit.

Figure 13. Global differences in adoption of mobile banking

Source: UBS, 2015

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In the EU customer protection is also much more regulated and therefore costs are an

extra factor in the performance matrix in the EU. Also in the adoption of mobile payments

there are large differences amongst countries as can be seen in figure 13. Although mobile

payment technology still needs to cross the chasm in many developed countries, it is

already becoming a mass market in China and parts of Africa. The main reason for using

mobile can be traced back in part to financial inclusion, but infrastructure (online

shopping) and social (media) also play an important role. It is likely that these differences

will have implications for the adoption of mobile payment technology in the future as well.

We expect that card usage will be dominant in the EU for a much longer period of time

than in China. In Africa and India it is likely that physical card usage will not reach mass

adoption anymore and that this step in the payment evolution will simply be skipped by

directly going mobile.

Millennials determine which technology will cross the chasm

More than half of the world’s population is younger than 30 years old and this group will

represent 75% of the working force by 2020. Millennials have different preferences and

habits when it comes to banking and payments. Although not allowed by the regulator, in

the US 72% of millennials would be happy to bank with a technology company rather than

a bank as can be seen in figure 14.

Several surveys concluded that about half of the millennials would be willing to make

payments via their mobile phone instead of their current preferred method of pay. The

most likely reason for this is that millennials already use their mobile phones to make

mobile commerce transactions. The extension of mobile use cases to payments is

therefore a natural one.

The fact that millennials are more open to use technology is one of the main reasons why

this generation is often represented in the early adopters and pioneer customer base.

Millennials are willing to try a lot of services and technologies, but they will only stick to

those that really add value to their performance metric. In practice we think it is likely that

developments in payments will go much slower than millennials would actually want.

Figure 14. Millennials are comfortable with tech companies as their bank

Source: Accenture – The Digital Disruption in Banking, 2014

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Rewards, safety, privacy and convenience are key for millennials Millennials are targeted in order to drive mobile payment technology adoption. If this

group does not start using it, the technology will never become mass market. Millennials

are most concerned about their safety and privacy. Eight out of ten millennials are

concerned about mobile security, while only two out of ten are concerned about card and

cash security7. They will switch payment providers instantaneously if there is a breach of

either one.

Besides safety and privacy, millennials also want to experience added value from their

mobile transaction versus a card. Rewards and warranty administration are benefits that

are often mentioned. Starbucks is an example of a company that integrated loyalty

rewards into its app. The app now has 12 million monthly active users in the US. In sum,

mobile payment technology has a chance to become mass-adopted, and with that to

become disruptive to some parts of the payment ecosystem. Creating a value adding

proposition is vital though.

7 JWTIntelligence.com, 2014.

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Summing it all up: winners and losers Global and niche networks are the most likely winners We think the technological, regulatory and socio-demographic trends are all positive for

network players like Visa and MasterCard. We think companies with scale or a specific

niche (like Amex has with travel) are the most likely winners. From the perspective of

technology we think networks are on a sustaining innovation curve and have surpassed

the point of technical disruption. From a regulatory perspective we think the barriers to

entry will continuously increase which benefits those that have scale. The opening up of

domestic networks in Europe and China is also positive. From a socio-demographic

perspective the continuing shift from cash to cards/mobile will be positive for networks.

Challenged industries are card issuers and pos terminal providers

For card issuers the costs of having a physical card are increasing due to security standards,

while on the other hand digital card issuers emerge that can offer cheaper payment

alternatives through the mobile phone. We believe that regulation will be negative for

issuers because co-branding is not allowed anymore and processing has to be separated

from issuing services in Europe. On top of that, the interchange fees will be cut as of next

year. In terms of socio-demographics we see negative developments for card issuers too.

Millennials are migrating more and more towards mobile. In countries where card

penetration is low we think it is hard to convince people to use cards versus mobile

alternatives that are most likely going to be cheaper.

Point of sale terminal providers are especially challenged from a technology perspective.

The introduction of mobile capabilities will have a large impact on this segment, we think.

Costs come down and a shift towards software is imminent. Regulatory standards have

thus far been positive for point of sale providers because of the liability shift in the US that

has increased EMV adoption. Socio-demographically we see that millennials want to be

able to use their preferred method of paying whenever they make a transaction. Mpos are

a positive development here as well because of the inclusion of small merchants in the

payment ecosystem.

In the rest of the ecosystem it is too early to announce clear winners and losers We think e-wallets and mpos providers are good examples of industries where we lack

visibility on winners and losers at this point in time. It is very likely that a mobile wallet

provider will become mass adopted for mobile payments, but we do not yet know which

one that will be. We do know that it will have to actually add value beyond simply

transferring money. It will have to be able to switch on-off insurances, advice on financial

matters and many more of these financial functions besides the transaction itself. The app

that can do that is not yet available though.

For mpos providers we also think it is too early to announce winners. There are over 200

mpos companies that all try to position themselves in some part of the payment terminal

industry. As long as the technology has not yet crossed the chasm in developed markets,

we have limited insight into winners and losers.

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Appendix A: Players in the ecosystem and their role

Figure A1. The payment ecosystem

Source: Visa, 2014

Role of an Acquirer: the acquirer (Chase, First Data, Bank of America etc.) solicits,

underwrites and owns the merchant account. Acquirers are part of the card networks and

provide technology and hardware, which enables the merchant to process the transaction.

The acquirers get a fee per transaction. The data is owned by merchants, which limits the

ability to use big-data for acquirers.

Role of the Issuer: The issuer is the bank (Capital One, CIBC, RBC, etc.) that provides the

cardholder with the credit card. They bear the responsibility of approving the cardholder

and billing and collecting the owed funds from the cardholder. In return the issuer receives

the interchange fee for every transaction. This fee is now capped in the US and the EU for

credit and debit card transactions. The interchange fees were high before the cap. The

main reason is that this fee contains processing fees, fraud loss provisions and used to be

an incentive for banks to issue and distribute cards at low costs to cardholders.

Credit Card Associations: Associations (Visa, MasterCard, AMEX, etc.), or Networks, are

commonly referred to as the credit card and debit card companies. The role of the

associations is to govern the policies pertaining to their bank cards, monitor processing

activity, and oversee the clearing and settlement of transactions. In addition they are the

most likely candidate to offer tokenization services. Networks play a key role and are one

of the few pockets that can operate in the ‘old’ and ‘new’ ecosystem. Associations earn

money by means of transaction fees.

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ISOs (Independent Sales Organizations): ISOs (Payfirma, Square, etc.) are organizations

that partner with acquirers to open merchant accounts, handle support, manage payment

processing, and build added-value technology on behalf of acquirers. ISOs do this in

exchange for a percentage of the transaction volume.

Processors: A payment processor is appointed by a merchant and handles transactions for

merchant acquiring banks. They are broken up in two types: front end and back end. The

front end processors connect to the card associations and deal with the authorization and

settlement process to the merchant’s bank. Back end processors move the money from the

issuing bank to the merchant bank and basically deal with clearing and settlement.

Processors also deliver a concept called Software as a Service (SaaS). These software tools

enable merchants to scan and validate paper money and checks, process card payments,

process ACH transactions, remittances and web payments.

Merchant: The merchant is a business owner who submits a request to an ISO/acquirer for

the ability to accept credit. Merchants are approved under the qualifications set by the

associations and the policy of the underwriters.

Cardholder: Cardholders (consumers) are customers of a bank that request a credit or

debit card. The cardholder will be approved by the issuer based on creditworthiness in case

of the credit card.

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Appendix B: Payment fees and flows

Figure B1. Payment fee flows in the US with Apple Pay example

Source: Deutsche Bank, 2015

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Appendix C: Millennials adopt mobile phones fast

Figure C1. Global smartphone penetration among millennials

Source: Microsoft, 2014

Jeroen van Oerle Patrick Lemmens Trend Analyst Portfolio Manager Robeco New World

Financial Equities

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