Variable Recurring Payments: Economics and Pricing, and the Cost of Getting it Wrong

There is rightly a growing interest in the potential of the OBIE’s Variable Recurring Payment (VRP) standard to stimulate competition in payments. VRP could allow open banking, with all its benefits, to provide new alternatives to direct debits and card continuous payment authorities for significant numbers of recurring and repeating payments.

The first use case for VRP has been mandated by the CMA, as part of its competition remedy, to provide sweeping services to consumers and businesses. These sweeping services will allow them to find better savings rates and alternative lending services to compete with bank overdrafts.

Beyond these specific use cases there is currently no regulatory mandate for Account Servicing PSPs (ASPSPs/Banks) to support other uses of VRP. Regulators and the industry in general expect these non-mandated services to be provided voluntarily and commercially by ASPSPs as so-called premium APIs.

Putting aside for a moment whether enough ASPSPs will voluntarily support VRP beyond the CMA9 and sweeping, which looks highly questionable at the moment based upon the lack of commitment from many ASPSPs and the inherent long-term cost to them of enabling services that will cannibalise their card issuance revenues, can a premium API commercial model work?

Rather than reviewing what different parties in the prospective VRP market might want from commercial models, here we look at the fundamental economics of the market and what these economics will allow to work.

We also compare the economic situation and structure we see with VRP and compare and learn from similar situations in mobile telecoms, and indeed the existing direct debit market.

The “Premium-API” – market driven and fair for all? Impossible. Here’s why….

Non-sweeping VRP has been characterised within the industry as the first example of premium-APIs, chargeable by ASPSPs to FCA authorised Third Party Providers (TPPs), that will financially encourage ASPSPs to support open banking.

For a TPP to deliver a credible VRP enabled service their product will need to support end-customers paying from accounts at all the major UK banks. But VRP payments initiation from each bank can only be provided by that individual bank. Only an end-customers own bank can provide VRP payments initiation to a TPP, no other bank or intermediary. To support, for example, NatWest payers, a TPP needs an agreement with NatWest, for Barclays paying customers an agreement with Barclays, etc. Each ASPSP is, de facto, a natural monopoly provider of VRP for its customers. TPPs will have to obtain VRP from each major bank in order to serve each bank’s paying customers. TPPs will have no choice or alternative and will have to either accept the individual commercial offers from each major ASPSP or not provide VRP services at all. There can be no competitive market for VRP API access, and as there is no market, there is no cost-oriented price setting mechanism.

Prices can’t be set by ASPSPs at the level they see is needed to achieve a particular market share, as they are not competing with any other providers, but, if they are offered at all, will be set by ASPSPs at levels that will neutralise the cannibalisation effects on card issuance fees which will be forfeited if VRP takes off. Also, prices charged will potentially vary substantially between ASPSPs and may even have different structures – some ASPSPs might offer a flat fee per transaction as used for direct debits, and others might charge a percentage of value, as used for card payments.

The probably high prices charged by ASPSPs to TPPs will have to be passed on by TPPs to their business customers, removing one of the key drivers of adoption for open banking for businesses – cost saving. Plus, it has the added complexity that TPPs will have to judge the mix of paying customer banks, and average transaction values in order to estimate what their aggregate ASPSP cost base will be. These factors are very significant barriers to the take up of VRP services from TPPs.

So how do you solve a problem like a natural monopoly?

The mobile telephony industry hit this problem 25 years ago as regulators investigated the prices telcos charged each other for terminating calls on their networks. In the telco industry in this situation, call termination doesn’t mean the ending of a call, call termination is the process of connecting a customer on your network to an incoming call from a customer on another network. In most of the world customers are not charged to receive calls, but their network charges the calling network, and the calling network then charges the caller for making the call.

Like VRP there is a natural monopoly in call termination. To call a Vodafone customer my network must buy call termination services from Vodafone. In the late 1990’s as call termination rates remained stubbornly high while other prices fell under the effect of competition, telecoms regulators around the world stepped in and set the prices networks could charge each other based upon the regulator’s analysis of the long-run incremental cost (LRIC) to an efficient market operator of providing the service. This has continued to date, and termination rates have been driven down by regulators to fractions of a penny per minute.

A regulated price? The less good option

So, one answer to the natural monopoly of VRP would be a common, regulator-calculated, incremental cost price. This is however far from a perfect solution. It requires agreement on the incremental costs, perpetual intervention from the regulator and most importantly gives up on finding a competition-based approach to setting prices to reward market players for their efforts.

Happily, whilst there were no alternatives for the telco market and mobile termination rates, hence the resorting to constant regulated and monitored pricing, there is an alternative competitive market approach for VRP that can reward ASPSPs for their efforts in delivering VRPs. We don’t have to look far for the model, to direct debits.

The multiple competitive markets option

For the direct debit service, ASPSPs charge their own business customers for the receipt, and sometimes for the paying of direct debits. Direct debit service providers that give businesses value added services to create, submit and manage direct debits also charge their business customers for those value-added services, but those service providers are not charged by ASPSPs. Everyone gets paid for the services they provide, and importantly, if a business is unhappy with the value-added services it receives it can change service providers, and if its unhappy with the bank charges to receive direct debits it can switch banks.

For VRP, the same model can, and should, apply. ASPSPs should charge their customers for the sending and receipt of the underlying Faster Payments that deliver VRP in the same way they charge for vanilla Faster Payments. TPPs should charge their customers for the value-add element of their VRP enabled services. This way all prices are set using competitive market mechanisms – businesses can switch TPP to get better value in VRP services, and switch ASPSP to get better value VRP derived Faster Payments. Indeed, for many businesses a full switch may not be required, simply moving the Faster Payments receipts to a different ASPSP would do the job.

This is essentially the same model as for current single open banking payments. TPPs charge their customers for their value-added services and ASPSPs charge their customers for the sending and receipt of Faster Payments initiated via open banking just as they charge them for their own channel initiated Faster Payments.

Getting competitively paid for value-add services provided

As is the case for single payments, with the VRP solution ASPSPs still get paid for the work they do sending and receiving the underlying Faster Payments, arguably they will make a higher margin as for VRP Faster Payments there is no cost of providing per payment Strong Customer Authentication (SCA) for the ASPSP.

To summarise:

  • Fundamental economics shows us that a premium API commercial model cannot work for VRP because each ASPSP is a natural monopoly provider of VRP services, so there can be no market set price.
  • The telco alternative of regulator set prices could work but is unnecessary and ignores an alternative competitive market approach.
  • Following precedent and using the commercial model we have today for direct debits and single open banking payments means competitive forces will keep costs low for users, and ASPSPs can be rewarded for the work they do providing the underlying Faster Payments via the market pricing mechanisms that work for standard Faster Payments.

What’s not to like?

Ordo’s Regulatory Call to Action

  1. The PSR/JROC must mandate the commercial model proposed here for all VRP use cases and providers. This model has already been adopted for the sweeping use case; premium APIs simply won’t work.
  1. Similarly, they must mandate at least the CMA9 to support all VRP use cases, not just sweeping; we won’t even get close to a critical mass of adoption without this driver.

These actions are critical to the future success of Open Banking in the UK and the maintenance of the UK’s leading global position in FinTech and payments. And even more importantly, they are a critical enabler for the UK’s businesses to use Open Banking to better serve and support their customers as the current cost of living crisis takes hold.

There are huge competition benefits from enabling the full utilisation of VRP, and the incremental costs to ASPSPs of provision are very low. But few ASPSPs will do this voluntarily given the likely cannibalisation of their current card issuance revenues.

For further insight into the arguments made in this paper see the recommendations of the Payments Systems Regulator’s Panel in their April 2022 Digital Payments Initiative report.

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