Credit risk management in epayment : case study of Ingenico epayment

Universiteit van Amsterdam – Amsterdam Business School

Credit Risk Management in ePayment: Case Study of Ingenico ePayment

Master’s Thesis

Author: Se Hyun Ahn (11371099)

Program: MSc Finance: Asset Management

Date: August, 2017

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Statement of Originality

This document is written by Se Hyun Ahn, who takes full responsibility of written contents in the main body of the article.

The diagrams and figures used in this article are wholly owned by ingenico ePayment, and have been given permission to be used for the thesis and this thesis only. No permission was given to export the diagram further than to the graders who will be marking this thesis.

I declare the text and the work presented in the documents are based on the experience gathered and knowledgebase of ingenico ePayment. Material in the articles are sourced from ingenico ePayment, otherwise stated, and is written as case study.

The lack of reference is due to the nature of case study and trustable articles available on the ePayment industry, thus heavily being based on private company booklet (unpublished to public).

The Faculty of Economics and Business is responsible for the supervision and completion of this article, not for the contents.

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Acknowledgement

I thank the staff of Credit and Investigations team at ingenico ePayment, especially Thijs Wetters (Europe), who was a mentor throughout my traineeship, and have walked me through the whole credit risk management process. Ingenico has provided me with much needed depth into fintech and

ePayment industry to fully understand the applied industrial aspects beyond the articles available to the open public. Finally I would like to thank professor. Liang Zou for allowing me to carry out a case study based on my traineeship position at ingenico ePayment.

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II. Payment Value Chain 12

a. Payment Value Chain and the different stake holders 12

b. Ingenico ePayment as Payment Gateway 15

c. Ingenico ePayment’s Stakes 16

d. Ingenico ePayment as Acquirer 17

e. Ingenico ePayment as Collector 19

III. Risk 21

IV. Risk Management 25

a. Operational Risk Management 26

b. Investigations Management 27

c. Fraud management 27

d. Chargeback Management 28

e. Credit Risk management 28

V. Concluding Remarks 32

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Abstract

With rapidly evolving fintech industry, it has become difficult to grasp understanding the operation and methodologies they apply. The case study of ingenico ePayment gives an opportunity to study the ePayment industry. In this article, the fintech will be discussed in detail, and how ePayment industry is classified as a fintech. The second part of the article will study the PVC, which informs the reader on who the stakeholders are in the ePayment industry. The third section will explain the detailed risk management ingenico ePayment implements to safeguard the risk. Finally, the concluding remarks on the current ePayment industry, the competitors, and the future of the ePayment services.

Keywords: Fintech, ePayment, eCommerce, Price Value Chain, Credit Risk, Risk Management

N.B.: This is a case study based thesis written during the period which the author was working as a trainee at Ingenico ePayment, under Credit Risk Management Department. All data and contents belong to the firm, and their case studies of merchants were removed to due to confidentiality conflict. The article is for grading purpose and the graders’ eyes only.

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I. Introduction

This case study investigates the risk management in the ePayment industry. The study will consist of exploring the ePayment industry and concentrate on ingenico ePayment’s risk management

methodology.

The financial market moves rapidly as the proverb “early bird catches the worms” explains, the faster you are able to adapt to the newly evolving markets and technological trend, the greater turnover you can enjoy. Financial Technology has become an essential anchor for the newly evolving trend. The evolution of artificial intelligence and automation process has moved from manufacturing to financial industries and have threatened many jobs over the past years. The smaller start-ups have been on the rise creating niche and services for larger financial institutions to employ them to automate their services. This essentially has moved many traditional financial sectors to adapt to newer, more computerised financial services.

To study the new fintech industries, one must experience the industry from the inside to gather information and knowledge of the industry as they are still extremely competitive and are unwilling to share their methodology openly. As a result, the only way to study ePayment industry and fully understand the process and methodology is to work and be trained in their risk department. The opportunity was graciously presented to the author for the trainee role, which he took and studied and presented in the form of this article.

With the exponential pace of development in technology and the connectivity between users have become stronger with passing years. As a result, the traditional business model for retailing and service industry had to realign themselves to match the modern market trends. The birth of online shopping lead to ever faster transaction for goods and services, which from the end user customer and the seller’s point of view is a positive outcome from the advancing technology. However, there are

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number of hurdles the stakeholders in the new industry have to overcome to reach the state we are enjoying at the moment. This article will highlight the ePayment, or also known as Internet Payment Service Provider (IPSP) industry, as it is relatively unknown and lack any academic article which wholly explains the industry in detail. The aim is to understand the Pricing Value Chain in IPSP and, how they operate. Finally the risk model the case study firm (Ingenico ePayment) is utilising to mitigate the risks (as the risk they are exposed to are vastly different to a typical financial institute).

The section I consists of introductory information, which will describes the eCommerce industry, IPSP (ePayment) industry, brief introduction to the case study firm: Ingenico ePayment, and defining tech-disruptors. Section II will study the in-depth methodology in which the IPSPs, specifically the stake holders in what is called PVC. Part III explains the risks entailed in ePayment industry. Section IV will take a look into how the risks are managed in the ePayment industry. Finally, section V will close the article with a conclusion, describing ingenico ePayment’s current status in the ePayment industry against other competitors as well as future of ePayments.

I.a. Tech-Disruptors

With rising start-ups who attempt to fill a gap in the current existing market, or to provide services where consumers exists with demand but no suppliers exists are being slowly occupied by the new start-ups who aim for these small but significant markets. These entities who manage to take full advantage of being the innovator and market shareholders by developing to specialise in the new innovative industries are labelled Tech-Disruptors. A prime examples of these merchants are firms such as Uber, Deliveroo, Airbnb and Tinder. These firms managed to provide services where previously may have existed with small market exposure and availability or not at all. With fine-tuning their marketing strategy and solid operations, the tech-disruptors are able to grow rapidly into a large stable company. As the prediction for rapidly growing companies becomes apparent, there will be large investors willing to take advantage to the rapid growth by injecting equity or debt into these

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rapidly growing firms. As an ePayment entity, the rapidly growing firms are also attractive as they are able to negotiate from a stronger position on processing fees and then enjoy large transaction premium when the tech-disruptor matures. Ideally, these are sound investment for the ePayment service providers. However there are strict regulation on who and what service ePayment service providers are able to lend their service to by regulations, as well as risks entailed in start-ups.

I.b. eCommerce Industry

Traditionally, when economists talk about retailers, they are given the concept where there is a physical presence of a shop front from which products from suppliers are sold to the end user consumers. However, with invention of online payment methods, the traditional retailing method has become largely inefficient or are outcompeted by online retailing merchants. The online payment methodology opened a new paradigm of retailing fronts. The first online payment began in the mid 1990’s, via credit cards. Initially, the customers were sceptical of using their credit card to pay for goods online as the world wide web has only been commercially active for about a decade. As a result, the eCommerce industry at its infant stage was barely recognised and regulated during this era.

As technology advanced, the users became more exposed to the existence of the eCommerce, the merchants in the eCommerce industry had to adapt to provide an easy yet safe methods for their consumers to pay with as well as guarantee to deliver their goods and services to their clients. eCommerce can be divided into three major items. First is the online retailing. Much like the traditional retailing industry, these are the websites where the merchant has the inventory of items stored in their warehouse, or has partners who will deliver their goods to deliver to their customer once the transaction is completed. Furthermore, one of the largest merchants for ePayment industry is the gaming industry. As both console and PC platforms now heavily rely on online transactions to sell their product. Second is the online service industry, which includes digital service providers such as internet, security, catering and other various traditional services can be booked. Third is the travel

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industry, which includes flights, rental cars, and cruises. The travel industry within eCommerce are more complicated as the end user often do not book their travel services directly from the service providers. Instead, the consumers often use Online Travel Agencies (OTAs) who provide cheaper tickets by bulk buying early in the season or have other agreement with the travel service providers.

Now that the main sectors of eCommerce industry have been identified, the biggest firms in these industries should be identified. In the retail industry, merchants such as Amazon or eBay dominates market in North American and European Markets. These firms have specialised into eCommerce retail industry, and are constantly developing and producing the best user experience possible for their consumers which drove them to be the industry leaders. In the gaming retail industry, the large AAA studios such as Bethesta, Blizzard, and Ubisoft to mention a few, dominates the market. However, as the mentioned firms are individual developers, we should also compare pure retailing company for games such as Electronic arts, who sell all games produced and developed by their subsidiaries, or Valve, who have created the largest online gaming retail services are m

Service industry ranges from infrastructures such as the internet provider, to delivery service. The eCommerce includes as already mentioned, any service transactions that included payment method without the credit or debit card not present at the point of purchase. The service industry is under high risk due to the ability to provide services to their customers greatly impacts the turnovers and reliability. As a result, the brand recognition is one of the largest facets in choosing the services of the named company for the consumers. This leads to heavy competition within the market between the competing firms, both with price competitiveness, service competition, and visibility. The firms in service industry typically aim for returning customers thus gaining brand loyalty. (NEED SOURCE)

Finally, another industry which is heavily invested in eCommerce are the travel agencies. Nowadays, simply putting port of departure and arrival on any online search engine will provide you with various Online Travel Agencies (OTA). The OTAs operate by purchasing large sum tickets

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much like an option from the airlines with discount (due to bulk buying), and reselling them.

Typically, they have small margins to their revenue, and are exposed to risks from the airlines which they service to the customers. Overall, the OTA has expanded from the airline tickets to other items such as cruise lines, hotel bookings, and car rentals as well. Typically the margin the OTAs receive is little, but the volume they handle can become extremely large. For instance, companies such as Booking.com has multiple industries in which they provide services from airplanes to hotels. These types of merchants are exposed to different risks as say a service or retail merchant, as their product is tickets and the non-delivery state is when an airline fails to deliver a seat due to extreme weather, or goes bankrupt. In these cases, the exposures of the OTAs become exponentially high as the average transaction amount tend to be much higher than a retail or service merchants. Furthermore, as consumers for the travel products tend to have high average liability period, as the consumers tend to book their holidays or travel arrangements far in advance, which also adds to the exposure a collector or an acquirer handles. The average refund rate are usually below 5% for flights, and between 5 to 10% in for hotels. Furthermore, for flights, the International Air Transport Association (IATA) receives payments, where they fully handle all products, thus liability shift occurs and credit risks are mitigated. For this reason, OTAs are one of the less riskier merchants.

To sum up the eCommerce, it is an extremely rapidly growing industry with on average 10% growth occurring on average per annum. As the growth is high and steady for the past years, so does the number of transactions and transaction amount has been increasing as well. A transaction is when a credit card, debit card, or other means of transaction is physically not present are processed. Due to the online process and the non-immediacy of transaction, there lies a credit risk in these types of transaction and the acquirers (the banks who processes the payments) are exposed heavily, thus charge a premium to the merchants to cover the risk as well as to gain revenues for providing the payment service.

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I.c. ePayment Industry.

With Growing eCommerce, the payment methodology must also improve. Most common type of online transaction are credit cards, which are dominated by the major credit card companies. With high barriers to entry into the market, the credit card companies have non-competitive premium rates for the merchants who process through them. As a result, service providers who offer lower premium rates entered the chain of transactions. This area of the cycle is called the ePayment industry, where the processing the payment for the merchants (the clients of PSP) occurs.

The ePayment industry divides mainly into the Payment Service Providers (PSP) and Technical Service Providers (TSP). These terminologies are set by the EU Directives (2015/2366), which are to regulate the industry. PSP is a financial institution regulated under the EU Directives. These institutions handle the e-money, payments and are mostly take to roll of Collector in Payment Value Chain (more detail in the next section). The TSPs on the other hand are unregulated, and takes the support role in the payment services by providing the payment services.

In short, they offer better deals than the issuers for the merchant, and allow the merchant to use wider method of payment, which opens up more customer base for the merchant. While PSP/TSP process these merchants for both card present and card not present (physical and online), they are able to negotiate lower premium rate with the issuers, and ultimately lower premium rate for the individual merchants while holding the credit risk of the merchant. Essentially, a the idea is comparable to the interest rate swaps (Hull, 2012), but instead, with a premium rates.

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I.d. ingenico ePayment

Previously known as Global Collect, the Global collect was acquired by the Ingenico group. As the case study for the thesis were obtained from the firm. Within the ePayment industry, ingenico is one of the leading entities when it comes to ePayments. The internship gave an opportunity for the author to study and investigate the in-depth workings of the ePayment industry, and how PSP/TSPs can value credit risks to protect themselves. Essentially, the risk mitigation, or risk management in PSP/TSP are different to that of a bank which there are many literatures covering the credit risks in banking sectors. (N.B. Full permission for using data and processing methodology has been given to write this article under condition that this article will not be published to the public)

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II. Payment Value Chain

II.a. Payment Value Chain and the different stakeholders:

The ePayment as in the name suggests is the process of online payment which is the transfer of funds, or transfer order with an attached obligation between the payer and payee. There are three main types of payments: the Credit Transfers, Direct Debits, and Payment Cards. These three types of payment method has different processes defined by “push”, meaning they are initiated or given, and “pulled” which means received, or taken. The table 1 (Lomon, 2016) simplifies the difference between regular and irregular process of payments.

Table 1. 3 types of transaction methods (Lomon, 2016)

Money Regular Process Irregular Process

Bank Transfer Pushed by Consumer

Merchant Relies on Consumer’s push

Consumer relies on merchant’s push (no

reversal right)

Direct Debit Pulled by Merchant

Merchant processes a debit on consumer

bank account

*Consumer can reject/return/refund

Cards Pulled by Merchant

Intermediary presents debit to consumer

issuing bank

*Merchant can refund consumer can

chargeback. *There are varying degree of complicated regulations depending on the irregular payment process

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Figure 1. Debit Card Transaction cycle (Lomon, 2016)

The debit card transaction cycle shown in figure 1, shows the flow of information and funds when transacting using direct debit card. Typically the process takes at most a day as the consumer bank and merchant bank transfer process is simple in sense that they only need to check for existing funds in consumer bank’s side in the consumer’s bank account whether they have sufficient funds. Contrary to the debit card transaction, figure 2 shows the credit card transaction flow chart.

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Figure 2. Credit Card transaction Cycle (Lombos, 2016)

As previously mentioned, the Payment Value Chain (PVC) is the chain of flow of payments which occur with largely three parties: the consumer, the merchant, and the bank. However, due to wide variety of payment methods and specialised financial institutions who handle different types of payment system, the chain becomes more complicated than the three main parties. As the PVC is the foundation of ePayment industry and their operations, the following section will explain the PVC in great detail.

To begin with, there are seven major stakeholders these are: the Merchant, Payment Gateway, Acquirer, Collector, Payment Scheme, Card Brands, and Issuer. In the following section, the

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stakeholders will be described in detail. The seven stakeholders can be split into three groups of merchant side, the consumer side, and the bank side. The acquirer and the collectors represents the merchant’s side of PVC, while the Payment Schemes and Card Brands represents the consumer side of PVC.

The Payment Scheme are most commonly known as a the credit card companies such as Visa, or Mastercard, which transfers the funds via their credit cards. They take care of the transaction of “credit”, which is the amount of funds the customer holds and owe to the merchant, pushing them both proof and the amount they are owed by the consumer to the merchant.

Lastly, The Issuer is a bank which processes the payment cards directly to the end consumers. The issuing banks holds the majority of the liability on the consumers’ end. Which means, the ability for the consumers to repay the debt which they hold to the issuing bank, or issuer on their debit card, or in case of credit card, the line of credit is provided for the consumers by the issuing banks. The Credit Card payment liability for no-pay is split between the acquirer and the issuer.

II.b. Ingencio ePayment’s stakes

Ingenico ePayment acts as a Payment Gateway, Collector, and Acquirer in PVC. They have acquired Ogone and Global Collect services and its subsidiaries who used to work as payment gateways, as well as firms such as IFS (formerly known as Tunz), and Easycash GmbH. Due to the size and organisation of ingenico, they cover majority of ePayment industry’s reach when it comes to market coverage. For this case study, the three stakeholder positions will be explained.

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II.c. Ingenico ePayment as Payment Gateway

The Payment Gateway is an eCommerce application service, or also known as a payment terminal provider that redirects payment flow for online (POS) retailers to payment chain. A payment gateway enables the movement of information between payment portal (e.g. websites, phone,

terminal) and the front end processor or acquiring bank. This process is more easily visualised by figure 3. Technically by EU Directives (2015/2366), the Payment gateways are called PSP or TSP. (throughout the article, the term PSP/TSP will be used often to describe the processing entitiy, in which case applies for all three position which ingenico ePayment is part of, including collector and acquirer)

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Figure 3. ingenico ePayment as Payment Gateway

*Key: [1] Purchase order (authentication), [2] ingenico processes the information in a secure mode, [3] ingenico sends the information in a secure mode to the acquirer, [4] the acquirer sends the transaction data for approval to the issuer, [5]/[6] the issuer sends confirmation and the transaction is cleared to proceed, [7] ingenico informs the merchant that the transaction successfully

II.d. Ingenico ePayment as Acquirer

The acquirer is a type of bank or a financial institution who process the Credit and Debit card payments for the merchant. the terminology originates from the act of accepting credit or debit card payment from the card issuing companies or banks. When acquirer lends its service to a merchant in a binding contract, this gives the merchant a line of credit. Line of credit under the agreement between

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the acquirers and the merchant provides the merchant with the payment receivables while the acquirer receives the premium (also known as acquirer fees) specified in the Terms and Conditions (T&C). The process can be summarised and more clearly visualised by figure 4 (Lomon, 2016)

Figure 4. Ingenico ePayment as acquirer

*Key: [1] Purchase order (authentication), [2] ingenico processes the information in a secure mode, [2]/[3]/[4] ingenico, being acquirer sends the transaction data for approval to the issuers, [5]/[5’] the issuer confirms to ingenico, being acquirer and the transaction clears, [7] ingenico informs the merchant that the transaction successfully.

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II.e. Ingenico ePayment as Collector

The Collectors are similar to the acquirers, in sense that they have the rights of transfer while holding obligations and liabilities. The separation between the collector and Acquirer is that the acquirer takes full responsibilities in the payment value chain whereas collector does not. In short, the collectors are similar to acquirer in sense that they are intermediary position between acquirer and payment gateway shown in figure 5.

Figure 5. ingenico ePayment as Collector (Lomon, 2016)

*Key: [1] Purchase order (authentication), [2] ingenico processes the information in a secure mode, [2]/[3]/[4] ingenico, being collector sends the transaction data for approval to the acquirers and the issuers, [5]/[5’] the issuer confirms to ingenico, being acquirer and the transaction clears, [7] ingenico informs the merchant that the transaction successfully.

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Figure 6. Collector, Acquirer, and Payment Gateway in action (Lomon, 2016)

To sum up the three types of ePayment industry ingenico ePayment covers, figure 6 explains visually in short what each entity as part of eCommerce cycle does. When consumer orders products through a merchant (the blue arrows) they are fed through every party for both credit and debit card payments all the way the issuers. The payments (red arrow)flows from consumer to the issuers (depicting the confirmation of payment), towards their issuers then who forwards the information towards the merchant. The Payment gateway only deals in information, or data flow as shown in figure 6, whereas the collector and acquirer deals in flow of funds from chain of payment in eCommerce.

The PVC on its own has not altered drastically from traditional card payments from before eCommerce, as the payments chains followed similar paths. The main difference that has come up since the emerging eCommerce is the large exposure to large variations of fraud from both the consumer and the merchant side. These risks pushes the premium charges for the merchants for suing

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payments services of larger banks or credit card companies extremely costly, as there are no concrete proof on how they can mitigate their credit risks. As a result, the ePayment companies such and ingenico steps in, offering their funds as collateral, and receiving lower premium from the issuers and card companies while charging slightly more than the premium they are paying to these processing entities and banks. By doing so, they are fully exposed to the fraud and other credit risks, but they are able to enjoy the premium rate swap rates. In the following section, the risks to which ePayment service providers are exposed to will be explained.

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III. Risk in ePayment

Risk Management

The previous section delved in depth to the players in the ePayment industry. In the PVC, the acquirers and collectors tend to hold majority of the risks from the merchant side of the PVC.

Typically, risk management has many facets, and larger a financial institution, the more facets they cover and are exposed to. In case of PSPs, they are exposed to the credit risk. The credit risk is

defined by financial institutions as the default (L. V. Carty, 2000). However, unlike banks, where their risk varies largely, as the various activities the banks partakes in to generate profits, the collectors and acquirers are limited to processing payment services for their merchants. As a result, the risk

management department still consists of compliance, legal, and risk department, but modelling used to calculate the risks differ greatly. The models in ePayment industry for the risks are less robust and quantitative as a bank use. The PSP/TSP’s risk lies only in default risks, which can be tested and investigated using multiple ways. In the following section, the credit risk management and CRL (Compliance, Risk, and Liability) ingenico ePayment employs to mitigate the risks will be explored in detail.

As the collectors and acquirers are exposed to credit risks from their line of credits as well as non-financial related risks which are under the compliance department. The risk in ePayment industry is a morphed version of a credit risk a bank may use. There are variety of factors which both the investigations team, who are the compliance risk managers and the credit risk managers share as well as some unique to each department. These differences comes down to simply whether the risk is measurable numerically or not. In this case study, the credit risk is the major focus, thus rest of the risks will be explained briefly.

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Chargeback Risks of Transactions, Merchant Risks such damaging brands for ingenico, or

illegal/unethical businesses, Compliance Risks such as regulatory and anti-money laundering scheme (AML), and acquirer compliances, fraud risks of transactions and other operational risks such as Payment Card Industry Data Security Standards (PCI DSS), Security, and data privacy. These risks exists for acquirers and collectors who process credit and debit card for both card present and not present. The only effective method of reducing the risks which ingenico is exposed to from the above mentioned risks are to constantly monitor, which has kept the risk at minimum. As the dangers of chargebacks

While risks are more conceptually explained in academic writing, ingenico has provided multiple examples of merchants who were high risks from each type of risks. As the focus of this paper is on credit risk management side, the risks related to Credit will be focused on. These risk types are: the recurring billing, subscriptions, free trials, auto-renewal models, Card Not Present Transactions, Transaction values over USD 1,000, Long lead time shipments (long time between purchase to delivery time), products affected by weather, products dependant on quality (selling information), extreme guarantees of results, gambling, and foreign exchanges are extremely

dangerous types of risks. The merchants who follows these activities are seen as high risk merchants, and are immediately forwarded to the RMC to discuss whether these merchants should be processed or not. The overall idea of the high risk activities of merchant is when there exists a long liability period of merchant, meaning that the consumer can always ask for a refund or chargeback due to extremely long period of delivery (or subscription length), exposure of the processor becoming large as each transactions are priced high, or merchants who are effected by outside force such as foreign exchange rates as well as agricultural merchants.

At a ingenico’s corporate level there are four risk identifiers from Credit, Investigations, Fraud, Chargeback which ingenico ePayment has risk management system. These are managed by

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their relevant departments with which follows both financial institutional regulations set by European Union (EU Directives, 2016). As this article is a case study with credit risk management, only Credit Risk Management will be explained in depth, and other risk management will be briefly explained in the following section of the article.

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IV. Operational Risk Management

This part of the article studies risk management by departments. The ORM is an overview of the four risk department which controls for the types of risks the four departments manages as shown in figure 7 (Lomon, 2016). The ORM is the key stone in organisation to avoid unnecessary risk while taking up to calculated risk to keep the firm profitable by keeping the group from becoming too conservative and missing opportunities to pick up potential tech-disruptors.

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Figure 7. ORM Chart (Lomon, 2016)

IV.a. Operational Risk Management (ORM)

The major credit risks and their mitigation method in PSP/TSP has been established in the previous section. Now, the process by ingenico ePayment on how they manage thesis risks in their operations will be explained in detail. The aim of ORM is for the risk management to protect the

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transaction businesses and to monitor the risks the ingenico as a group are exposed to on a daily basis and manage them to an acceptable level. ORM can be seen like the safety net for the company from falling debris. ORM is there to make sure that the cracks and chains do not become prevalent for a systemic crisis as described by Reason (2013) from occurring. The strict ORM allows for PSP/TSP to follow the regulations set out in the ePayment industry, acquirers’, and card scheme regulations. ORM essentially combines the four big risks and combines them to keep the company at group level to manage risks by each department supporting one another.

IV.b. Investigation Management

Investigations department is the internal KYC department of ingenico ePayment. Many other PSP/TSP generally outsource for KYC, but ingenico’s scale allows to have internal KYC department. The investigations search for illicit activities the merchant may be participating in and test for AML, ATF along with other qualitative data. They are also in charge of preparing templates for annual review as well as gathering merchant details.

IV.c. Fraud Management

Fraud team checks merchants who are unwilling to use the ingenico’s fraud services provided for the merchants. In this case, the merchants are likely to have their own fraud tools to prevent them from CB frauds or other potential exposure to credit card frauds. The Fraud team bases their

operations around the daily monitoring chargebacks, as well as testing OLV models (refer to glossary section, as fraud is not directly relevant to credit risk).

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IV.d. Chargeback Management

Chargeback management team Monitors the CB rate per merchant. By doing so, they are able to reject potential new merchant with high chargeback liabilities. the CB monitoring is not purely based on the CB rate, but also include other security compliance with the merchants such as including 3-D Secure for CC transactions and other security measures against chargeback frauds.

IV.e. Credit Risk Management

In previous section, the potential risks the collector and acquirer (PSP and TSP) are typically exposed to in an ePayment industry and how they are managed were briefly summarised. As these departments are common for outside the ePayment industry and there are multiple external sources for reference available publicly, they were not pursued in depth. The credit risk management section will study the full definition and methodology to the credit risk the PSP/TSPs are exposed to, and will also explain how they are managed by the credit managers. As each PSP/TSP have different methods to measure and mitigate risks and as this article is a case study of ingenico ePayment, the risk

measurement and mitigated will be explained using ingenico’s methodology. In the Credit risk management side, the reviews done by the credit managers (abbreviated from credit risk managers) to keep the merchants risks in check studies two aspects: exposures and default risks.

Exposures are the amount (calculated in EUR amount) ingenico is exposed to in case of default. This is calculated by combining the average liability period, transaction flow overview, chargeback rate. The average liability period is the delivery period, where the merchant is liable for chargebacks and refunds. As a result, the longer these periods, the more exposure there is for ingenico. Transaction flow amount increases the exposure of the ingenico, simply as more transactions are made, there will be higher volume and amount being processed by ingenico as

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PSP/TSP, thus in case of default, the exposure is great. Lastly, the chargebacks are as explained previously, in case of non-delivery, the ingenico is liable to return the withholding cash. However, the chargebacks only slightly effect the calculated exposure amount as the compliance team already blocks and checks any merchants with chargeback rate higher than 1%. This means, in the credit department, there are hardly any case where chargeback rate on CC transactions are great enough to impact the exposure calculation.

Default risk is the calculation of the likelihood of a merchant declaring bankruptcy and defaulting. This rating is calculated by Capital IQ, which gives a sovereign capped 1 year PD, (probability of default in a year). The percentage defines the rating within S&P which the typical ratings are seen for stocks and shares in alphabet format (AAA, CCC-, etc.). Using this value and studying the company’s P&L (Profit and Losses), BS (Balance Sheets), and cash flow, the credit managers are able to conclude on the growth of deterioration trend of the merchant to be used for the default risk assessment.

Typically, the PSP/TSP are called to be holding debts for processing a merchant, thus when there is a default, PSP/TSP are in third place for priority list for legal rights to be paid fully with the liquidity the merchant holds (Cash Holdings). Due to this reason, one of the keystones of the risk management is to compare the cash holdings to the exposure, and checking the balance sheet of the merchant to examine the long and short term liabilities of the merchants. The balance sheet allows credit managers to assess long term ability to continue operations while paying off their debts. By doing so, PSP/TSP are able to immunise against the risk of default of the merchant.

Now that the risks the PSP/TSP such as ingenico is exposed to have been explained, the following section will describe how ingenico group cull such risks. The culling of risks is called “Risk Mitigation Controls” (RMC). These are often filled out for existing or new merchants who are

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consists of directors and chair level individuals). In the RMC, the relevant managers for the merchants are gathered to discuss and come to a decision whether to continue processing in case of existing merchant, or begin boarding for the new merchants. The relevant managers must investigate the business case for the RMC merchants, where relevant risk managers studies and understand the merchant’s products, services, and financials to seek and control the potential risks. By studying the business model and financials, the committee can draw out an agreeable T&C to mitigate the potential risks from the risky merchant.

There are four main tools in which ingenico ePayment uses to cover the risks to which they are exposed when processing a merchant. When reviewing a merchant, the risk managers investigate the exposure the ingenico ePayment as an entity is exposed to. This means, the loss ingenico will make when the merchant being processed is unable to pay the PSP for the amount they have transacted over a period of time. The details to how the exact numbers cannot be shown as the Non-Disclosure Agreements forbids exposing company details. As a result, the basic guidelines and tools used to immunise against exposure will be explained.

The first and second tool is the Bank Guarantee and the Fixed Deposit. These two tools are combined together as they effectively have the same function as each other. These funds are stored in the collector or acquirer’s funds for indefinite amount of time until the merchant wishes to terminate their service contract with the PSP/TSP they are processing with. These two deposits provide a point in which the PSP/TSP can use when the merchant fails to deliver in their part of agreement.

The third tool is rolling reserves is when the PSP/TSP holds certain percentage of processed transactions with the merchant. The PSP/TSP is able to hold on to these amounts in case of

bankruptcy in their account. The Credit Managers prefer holding Rolling Reserves (RR) as a method of risk management, as these funds are collected for two quarters and then released again after. This results in building of the reserves which moves with the merchant’s growth. Compared to fixed

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deposits, if the merchants grows at an extremely fast pace, which is often the case in the eCommerce, the PSP/TSP’s reserve amount increases with the increased transaction flow, which also creates a fluid reserves for fluctuating size of the merchant and no additional need to change T&C over the long term.

Lastly, the delayed remittance, which controls the chargebacks. Essentially, the delayed remittance “delays” when the transaction that is held by PSP/TSP which they are processing for the merchant. This way, if the merchant fails to deliver goods within certain days and the consumer requires chargeback, the PSP/TSP does not have to pay back from their own account. The default delayed remittance is set as two days, as it is the normal duration which it takes for a transaction to be completed between the issuing bank and the credit card providers. As delayed remittance is largely from use of line of credit, this method is only used for credit card transactions. The debit cards simply bounce and are much quicker to return the payment, thus no need for the delayed remittance on the DC’s transactions.

Using these four core tools, the credit risk managers are able to mitigate majority of the exposures. However, depending on the firm’s financial status, it may be difficult to implement these tools. As a result, the negotiation between the credit risk managers (CRM) and the merchants take place, where the CRM will hold attempt to understand the exposure of the merchant, and their risk ratings given by ratings agency (S&P in ingenico’s case), and using other information from

compliance and legal department, the CRM can draw and bargain for a risk management against the case of default. The form of risk management which ingenico ePayment employs can be seen as much more fluid and case by case standard over banking sector, who rely heavily on quantitative data. This can be explained by lower number of clients the TSP/PSP handles compared to a large corporate banks who are dealing with thousands of firms who are want to borrow from the bank or to use their services. In this sense, that the bank’s risk analytics suit their large number of clients.

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V. Concluding Remarks

Throughout the article, the ePayment industry was studied to provide a better understanding to the readers, as there are no published work on the industry as they are still relatively young industry with handful of players worldwide. Ingenico ePayment as an entity has enjoyed the market dominance in the last few years. However two other main players have joined the ePayment industry who are seriously competing and rapidly gaining market shares. One of these entity is called Adyen, a Dutch PSP entity who saw 100% growth in revenue every year since 2013. Adyen’s success comes from price competitive nature as well as speed of boarding. This allows new merchants to start processing with Adyen within one or two days. By doing so, Adyen has attracted more smaller merchants who eventually accumulated into large turnover and are taking over the market share of ingenico

ePayments. The same story applies for World Pay, who also compete fiercely for market share in the ePayment industry. World Pay is able to out-compete in both price and speed of boarding to ingenico ePayment. Furthermore, other than price and competing with speed, World Pay and Adyen are also able to take in more riskier merchants as their corporate regulation differ to the ones of ingenico ePayments.

With ingenico ePayment losing market shares, and failing to board and grow as quickly as Adyen, one could question the longevity and future of the ingenico in the ePayment industry. There is one aspect which no other PSP/TSP are able to provide to their merchant. With the size and capacity to care for their merchant, ingenico ePayment provides what is known as “full service” in the ePayment industry. This means, from boarding to processing, ingenico takes full responsibility by walking through the process with the merchant as well as the after service, client care, and constant monitoring. Other PSP/TSP simply lack the resources to perform these tasks, and must push on with the cheaper pricing and speedy boarding. As a result, the merchants who use ingenico and other cheaper alternative PSP/TSP differ. While Adyen and World Pay are able to attract smaller firms or

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start-ups, ingenico attracts more mature firms such as Blizzard, Valve, whose transactions alone accounts for majority of the company’s revenue from processing them.

Compared to the larger PSP/TSPs, there are other PSP/TSPs who have grown and prospered in the niche market other larger PSP/TSPs are unwilling to provide their services. A prime example is a company called Trans Venture. Most Acquirers and Collectors are unwilling to process firms who sell products and services which would damage the brand image such as adult entertainment products and services. Trans Venture’s main line of customers are adult product or content producers, who are neglected by other PSP/TSPs.

As ingenico targets more mature firms, ingenico is left with little room to grow. This left the Chair level management at the group level uneasy about their position, thus started implementing hiring freezes and cost cutting in their offices to drive up the profit. From a logical perspective, the managers should realise that there are difficulty in growing a 4bln Euro group entity by more than 10% every year without a tech disrupting products. As the cost cutting occurs, their objective of higher growth will inevitably conflict with cutting costs mean there are less room to develop further from current state.

As described, in the beginning of this article, ePayment is still a growing and developing fintech industry. It is nigh impossible to say for certain where the future will take the ePayment industry with emerging digital currencies such as bitcoin, there are no real answers to how these can be processed in the future in case they do become more predominantly used transaction for the merchants. There are still many obstacles and uncertainties ahead in the ePayment industry in order to define the exact procedure and risk management within the ePayment. As the experience working in the risk management in ingenico ePayment has further proved that the risk management based on numerical models alone is next to useless when a portfolio of merchants vary so drastically from a retail merchant to an FX merchant, as well as depending on the location, size, the business models of

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the firm that no single model could possibly cover them all.

Summarising the risk management in ePayment industry, the need for specialised risk management is necessity to operate at full capacity as there are strict regulations for financial institutes including the ePayment industry. The risk management should thus be based on both qualitative and quantitative method that studies case by case of the processing merchant to assess the risk entailed with each merchant. As shown with the ORM ingenico, from preliminary checks such as KYC and other qualitative data are gathered to be used in concert with financials and other hard accounting and audit figures of companies. As the ePayment industry begins to matures slowly, another obstacle approaches in form of crypto-currencies. PSP/TSP and many other financial

institutes are uncertain whether the crypto-currencies are the new tech disrupting tools or a bubble that has become a hype recently. They are unsure the future ruling for the regulations for the crypto-currencies, and are biding their time whether a new risk management needs to be implemented. Only time would tell the future of ePayment industry and the winner will be the ones who adapts to the new evolving technologies in the fintech.

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VI. Appendix I: Glossary

*The following section includes terminologies used in the article which may have not been clearly explained.(Lomon, 2016)

COMPLIANCE

AML "Anti-Money Laundering": framework of actions performed by regulated entities aimed at identifying funds which may come from illegal activities or transactions which are performed for the sole purpose of hiding the illegal source of funds and give to these funds the appearance of a legal origin (for more information on money laundering see "placement", "Layering" and "integration"):

● Conversion or transfer of money or assets for the purpose of concealing or disguising their illicit origin or assisting any person who is involved in the offence from which this money or these assets derive to evade the legal consequences of his actions;

● Concealment or disguise of the nature, source, location, disposal, movement or ownership of money or assets known to be of illicit origin;

● Acquisition, possession or use of money or assets known to be of illicit origin;

● Participation in, association to commit, attempts to commit and aiding, abetting, facilitating and counselling the commission of any of the acts referred to in the foregoing three items; ● Source of funds is always illicit;

● Money trail is circular since money eventually ends-up with person who generated it. AMLRO "Anti-money laundering reporting officer": designated person in a regulated entity (or in a central contact point when the regulated entity operates but is not located in a given country) who is in charge or sending suspicious activity reports to the local financial intelligence unit.

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ATF "Anti-terrorist financing" (or counter-terrorist financing): framework of actions performed by regulated entities aimed at identifying funds which may be transferred or used for the purpose of supporting terrorist activities or preparing terror attacks.

CDD "Customer due diligence": encompasses all the controls performed on a customer to identify its lawfulness, integrity, credit risk, money laundering risk, etc. CDD is performed when first starting the relationship, whenever a change occurs on the customer information, and otherwise on a regular basis (the frequency of which depends on the customer risk).

CTF “Combating the Financing of Terrorism” is financial crimes with economic effects: framework of actions performed by regulated entities (see. ATF).

FIU "Financial intelligence unit": national regulatory body dedicated to anti-money laundering and anti-terrorist financing, to which regulated entities must report any suspicious transactions. One the main purposes of financial intelligence is to identify financial transactions that may involve tax evasion, money laundering or some other criminal activity. We currently have the different national regulatory bodies:

● US: FinCEN (Financial Crimes Enforcement Network); ● France: TracFin;

● India: FIU-IND (Financial Intelligence Unit); ● UK: SOCA (Serious Organized Crime Agency);

● Brasil: COAF (Conselho de Controle de Atividade Financeira).

INTEGRATION (ML) "Integration" (ML): last stage of the money laundering process, aimed at getting back the money after having given it the appearance of "clean" money.

KYC "Know Your Customer": identification of customers through registration documents for legal entities (e.g. extract from national register, statuses) or identity documents for individuals (e.g.

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passport or ID card, legal document with address). The goal of KYC is to ensure that the data we have in our customer database correspond to reality, which is a legal obligation for all regulated financial entities in EU since the adoption of the 1st AML directive and for all other entities outside EU (local Central Banks directives). In EU, this obligation is reinforced further with the 2nd AML directive and with the 3rd and then with the 4th AML directives particularly with regard to the identification of the ultimate beneficial owners. Usually, KYC activities are performed during on-boarding and ongoing oversight throughout customer lifecycle.

KYCC "Know Your Customer's customer": identification of the customers of

merchants/intermediaries which are our direct customers. KYCC is not required per se by AML regulations. However, it may be necessary in the case of intermediaries acting on behalf of merchants, for sanctions compliance or anti-terrorism financing.

LAYERING (ML) "Layering" (ML): money laundering technique aiming at separate the illicit money from its source, by performing layers of financial transactions that obscure the audit trail and sever the link with the original source of funds

PEP "Politically Exposed Person": individuals who are or have been entrusted with prominent public functions (e.g. persons with a public mandate or past public mandate, high ranking persons in a governmental body, board members of public companies), as well as all their related persons (direct relatives and people living at the same place).

PLACEMENT (ML) "Placement" (ML): first introduction of funds coming from illegal activities in the legal economic circuit.

RESTRICTIVE MEASURES Restrictive measures are trade restrictions imposed on countries by a given country (e.g. US) or group of countries (e.g. EU). They may be general (e.g. US on Cuba), or target specific goods (e.g. EU on Libya for military supplies).

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SANCTION LISTS (EU) EU sanctions lists are divided in two groups: lists related to countries under restrictive measures (see "restrictive leisure’s") and terrorists lists (one for al-Qaida and one for all other terrorists). SANCTION LISTS Lists of individuals and legal entities which are put under economic sanctions by a given country (e.g. US) or group of countries (e.g. EU, OECD). Sanctions usually comprise the freezing of funds owned by the entities or individuals, the prohibition from helping them get new funds, by the acquisition of credit or the sale or resalable goods, the prohibition from entering into any financial agreement or investment, etc.

SAR “Suspicious Activity Report” (SAR): report made by a regulated entity to a FIU regarding suspicious financial activity detected among the operations performed by the entity. A SAR usually contains information about the customer involved (KYC), the transaction flows, as well as any financial and non-financial information resulting from a pre-investigation explaining why the transaction is deemed suspicious.

SHELL BANK Shell bank is a bank without physical presence in any country. SHELL ENTITY Shell entity is an entity that is incorporated in a country but has no assets or operations.

UBO "Ultimate beneficial owner": when a customer is a legal entity, the ultimate beneficial owners are the individuals who ultimately benefit from the funds of the entity. They can be administrators, shareholders, members (in the case of associations), etc. Usually, we consider all individuals who have (directly or indirectly) an interest of 25% or greater in, or who otherwise exercises control over, a legal entity.

CREDIT

DOWN PAYMENT A “down payment” is a partial payment made at the beginning of the purchase of an expensive good or service. The payment typically represents only a percentage of the full purchase price. Making a down payment and then paying the rest of the price through instalments is a

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method that makes expensive assets more affordable for the typical person. In card present, down payments are very usual in the following sectors:

● Electricity provider; ● Optical retailer; ● Furniture retailer;

● Or other High value goods retailers (such as car, jewellery).

Down payment represents a risk born by Ingenico, acting as acquirer, in case the consumer makes a down payment (or first instalment) through its card and never receives the goods or services

(merchant collapsed in the meantime).

EXPECTED GROSS EXPOSURE (EGE) EGE means “Expected Gross Exposure”, corresponding to the maximum credit risk exposure before securities or transfer of chargeback liability shift to our acquiring partners (when applicable), in the event of a merchant (CP or CNP) going into bankruptcy and not able to provide services or deliver goods ordered by consumers. This is calculated based on:

● Annual volume (in €) of collected or acquired transactions on CC/DC/OLV®; ● Chargeback rate (in %) for a certain duration;

● Refund rate (in %) for a certain duration;

● Down payments (in %) (only applicable for CP and when applicable); ● Liability period (depending on the goods / services provided);

● Anticipated remittance of funds.

EXPECTED NET EXPOSURE (ENE) ENE means “Expected Net Exposure”, corresponding to the expected gross exposure after securities and chargeback liability shift to our acquiring partners (when applicable). This is the maximum expected credit risk exposure without taking into consideration the financials of the merchant (credit scoring). ENE = EGE – Securities – liability shift (when applicable)

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ADJUSTED EXPECTED NET EXPOSURE (AENE) Adjusted ENE means “Adjusted Expected Net Exposure”, corresponding to the expected net exposure after taking into account an upwards / downwards adjustment factor based on the credit risk rating. Adjust. ENE = ENE x adjustment factor

LIABILITY PERIOD Liability Period (or duration of liability) is one component of the credit risk assessment in Card Present / Card Not Present each time INGENICO is acting as Acquirer or Collector. The liability period is the number of days between the payment acceptance date and the date when services are rendered or goods delivered by the merchant to the final consumer. Examples:

● In Card Present: Furniture stores (with down payments), airline tickets in a travel agency, ... ● In Card Not Present: goods retailers (usually btw. 3 days to 60 days), airline tickets / hotel

booking (usually btw. 15-90 days), Social Networking with monthly or annual fees (usually btw. 30 - 180 days).

MCC "Merchant Category Code": a merchant category code (MCC) is a four-digit number assigned to a business by credit card companies (for instance, American Express, MasterCard, VISA) when the business first starts accepting one of these cards as a form of payment. The code reflects the primary category in which the merchant does business. Additionally, the MCC is used to classify the business by the type of goods or services it provides.

SECURITIES In some cases, Ingenico Group agrees to bear the credit risk, depending on the merchant's credit profile in credit / debit card acquiring or collecting activities. Depending on the credit exposure, some securities are required in order to limit the potential risk. Usually, Security types are: ∙ Cash /Cash-Assimilated security types includes delayed funds settlement, rolling reserve deposit, fixed deposit and / or bank instrument; ∙ Non-Cash security: parental guarantee, bank guarantee.

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DATA CONTROLLER “Data Controller” means the natural or legal person, public authority, agency or other body which, alone or jointly with others, determines the purposes and means of the processing of personal data; where the purposes and means of such processing are determined by Union or Member State law, the controller or the specific criteria for its nomination may be provided for by Union or Member State law.

DATA PROCESSOR “Data Processor” means a natural or legal person, public authority, agency or other body which processes personal data on behalf of the controller.

DATA SUBJECT Data Subject” means an identified or identifiable natural person which personal data are being processed. An identifiable natural person is one who can be identified, directly or indirectly, in particular by reference to an identifier such as a name, an identification number, location data, an online identifier or to one or more factors specific to the physical, physiological, genetic, mental, economic, cultural or social identity of that natural person.

GDPR “General Data Protection Regulation” is replacing the EU Directive 95/46 EC and has been adopted by the European Parliament on April 14th 2016 This regulation will be enforced by May 25th 2018 and will extend the scope in terms of data privacy processing.

PAYMENTS

AGENT / DISTRIBUTOR Agent means a natural or legal person which acts on behalf of a payment institution in providing payment services. Electronic money institutions are allowed to provide those payment services through intermediary agent. Distributor means a natural or legal person which distributes and/or redeems electronic money on behalf of an Electronic money institution. Electronic money institutions are allowed to distribute and redeem electronic money through intermediary distributor.

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ALTERNATIVE PAYMENT METHODS (APMs) “Alternative Payment Methods” (APMs) are usually defined as non-card payment methods and tend to have lower fraud & security concerns. This covers a wide variety of payment methods, that can be segmented in multiple ways:

● Categories: Bank transfer, direct debit, wallets, pay later, digital currencies; ● Card based vs. “true” APMs;

● Online only vs. F2F vs.; ● Open loop vs. closed loop.

BANK TRANSFER This is one of the most common payment instruments. Bank Transfers are instructions sent by a payer to its bank requesting that a defined amount of funds be transferred to the account of a payee. Credit transfers may be submitted to the payer's bank in either paper or electronic form, but as a rule further processing occurs in electronic form.

CHIP & PIN Chip & PIN is the most secure type of technology for credit and debit cards. Rather than physically signing a receipt for identification purposes, the consumer just enters a four (to six) digit Personal Identification Number (PIN). This number must correspond to the information that is stored on the chip. Chip & PIN technology makes it much harder for fraudsters to replicate, so if for some reason a customer’s card is stolen, there will be no fraudulent purchases unless the criminal knows their four digits PIN. In 2016, Chip & PIN is more common in European countries (UK, Ireland, France, Netherlands ...) as well as in Canada and Australia. The major benefit is the improvement of the security against fraud compared to magnetic strip card transactions that rely on the cardholder’s signature.

CHIP & SIGNATURE Chip & Signature is the fact to sign a receipt for identification purposes for credit and debit cards purchases. Unlike Chip & PIN, Chip & Signature is less secure as it is easier for fraudsters to make fraudulent purchases. As of 2016, Chip & Signature cards are more common in the United States (under EMV migration).

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DIGITAL WALLET / EWALLET "Digital Wallet" means a service accessed through a device (e.g., a PC) which allows the wallet holder to securely access, manage and use a variety of services/applications including payments, identification and non-payment applications. A digital wallet is sometimes also referred to as an e-wallet.

DIRECT DEBIT This is one of the most common payment instruments. Direct Debits are payment instruments authorizing the debiting of the payer's bank account. Direct Debits are initiated by the payee on the basis of authorization given by the payer. The authorization by which the payer consents to have its account debited in a direct debit transaction is called a "mandate". National rules vary as to whether the mandate has to be given to the payee or to the payer's bank. The payee or the payer's bank may have an obligation to notify the payer before debiting the account. In India, this is called “Net Banking”. If there are insufficient funds on the payer's bank account, then the payer's bank is usually not obliged to honour the payment and returns the direct debit to the payee unpaid. Direct debit are submitted and processed in electronic form.

EASYACCOUNTING ”EasyAccounting” is a product offered by INGENICO Payment Services “IPS”. The settlement is processed via an IPS account and the respective cardholder accounts are debited by processing through an IPS account in trust. The money transfer to the respective merchant is then made from this IPS account. IPS offers better rates – due to well-price account terms – than the merchant’s house bank. Only the payment schemes ec cash and OLV® Acquiring can be combined with this product. “EasyAccounting Plus”: same proceeding but also available for payment scheme OLV®. To shift the chargeback risk to the merchant, the following conditions need to be fulfilled:

● Separate agreement between IPS, IPS bank, merchant, merchant bank (so called four-parties-contract “Vierparteienvertrag”);