Disruptive Innovation in the Payment Industry

City of London panoramaOver recent years the financial sector has confronted a dramatic increase in innovation in technology, services, and platforms and to some degree in organisational structure. The need to innovate is broadly-based and not just a financial sector challenge.

Typically in financial services, as in most other sectors in todays world of increasing hyper competition, there is a strong focus on the start-up ecosystem as an engine for disruptive change. Agile startups can bring disruptive innovations at a pace the established and slow-moving banks and other large financial sector firms cannot, building on drivers like the impact of high-capacity global mobile telecommunications, the availability of high performance business platforms, new software development techniques, the disruptive power of open source development and utilisation of other business model ecosystems as platforms, like the IOS and Android smartphones.

imageAnother strong driver for change comes from regulatory reforms. Following the global financial crises of 2007/2008 and the great recession it caused, the on-going regulatory overhaul of global financial services regulation is radically reshaping financial markets.

The reforms are driven by G20, the Basel Committee on Banking Supervision, the EU and national governments and it is coordinated across national legislation. The main challenges today relate to just how much change is coming at the same time and the complex competitive/co-operative drive to address issues internationally.

In this new landscape, implementation demands are set to dominate the big banks, asset managers´ and payment providers’ product and service offerings and investment decisions for many years to come, and one sector which is going through regulatory reforms is the payment industry.

In Europe, the Payment Services Directive One (PSD1), adapted in 2007 and updated 2009, was an EU Directive, administered by the European Commission to regulate payment services and payment service providers throughout the European Union (EU) and European Economic Area (EEA). The Directive’s purpose was to increase pan-European competition and participation in the payments industry also from non-banks, and to provide for a level playing field by harmonizing consumer protection and the rights and obligations for payment providers and users. PSD1 brought us cross-Europe SEPA payments, for examples.

PSD2Since adaption of PSD1, the retail payments market has grown significantly, and new payment services have been developed. However, the payments market is still fragmented along national borders, some payment products and services are out of scope, and some parts of PSD1 became too ambiguous, too general and outdated. This has resulted in legal uncertainty, potential security risks in the payment chain and a lack of consumer protection in certain areas. It has also made it difficult for innovative and easy to use digital payment services to establish and take off.

The European Commission therefore proposed new rules to close the regulatory gaps and provide more legal clarity, a consistent application of the legislative framework across the Union, new means of payment and a high level of consumer protection in the new Payment Services Directive 2 (PSD2).

PSD2, was adapted by the European Parliament on October 8th 2015 and it replaces PSD1. One key new provision is opening the EU payment market for companies offering consumer or business-oriented payment services based on the access to information about the payment account, the so called “payment initiation services providers” (PISP) and “account information services providers”.

Driven by the possibility of new technologies and the regulatory reforms, payments startups have been seeing considerable momentum, and are on track for 3.8 billion dollars in funding this year. From point-of-sale solutions to money transfers and mobile payments, these startups are changing how electronic payments are made, accepted, and processed.

CB Insights, a a venture capital database and angel investment database company which provides daily real-time information about venture capital and angel  investments, has identified an interesting list of 109 private companies in payments and mapped them according to the nine main categories where they are operating. Several of these companies are so called “Unicorns”, i.e. a company whose valuation has exceeded the somewhat arbitrary value of $1 billion.

The 109 payments startups included are addressing general payments needs as well as a range of payments market niches, including bitcoin-powered payments, mobile commerce, and specialised consumer-focused payment markets. Below is a graph of the companies mapped in the nine categories.

Payment industry

The breakdown is as follows:

  • Online payment services: Startups including Stripe and WePay that help businesses move their payments-processing online and make it more available,  secure, and inexpensive.
  • Billing automation and streamlining: Zuora and Paymentus, among others, streamline invoicing and automate financial processes and billing.
  • Point-of-sale payments: iZettle, Revel Systems and  others offer point-of-sale products and services, including card readers, stands, and digital storefronts. These startups compete with now-public Square in some segments, although Square has put more of an emphasis on small business lending and financial services more recently.
  • Personal payment services: Companies like MobiKwik and Affirm focus on providing consumers with more convenient payment platforms. Some of these companies focus on particular consumer niches.
    Bitcoin payments: Companies like Coinbase and BitPay that use digital currency to make payments faster and more secure.
  • E-commerce payments: Klarna and other startups focus on the e-commerce market with payments solutions geared to the challenges seen by online merchants. Klarna, for example, extends instant credit for online purchases to consumers without them having to provide payment details, easing the friction involved in completing an online transaction.
  • Connected card payments: Companies like Coin and Stratos are betting that all-in-one connected credit cards will be a key link in the payments value chain.
  • Money transfer services: TransferWise and Remitly provide digital solutions for sending money across borders quickly and cheaply.

Head over to CBInsights home page, for a complete list of the companies and their investors.

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