It’s evolve or die time for traditional acquirers as they struggle to bring down costs and innovate at the pace required to compete with the new bread of acquirers and PayFacs. Traditional issuer-acquirers and monoline card acquirers must evolve and become the enemy they are trying to defeat. One of the more interesting paths to achieving this is by creating internal PayFacs that deliver better economics and faster product delivery. However is this really possible given their more traditional ownership structures, capital allocation approaches and risk guidelines?

Payment Facilitators (PayFacs) have been around for a while and are a staple part of the acquiring market in both Europe and the US. While the model was originally pioneered by mPOS providers such as SumUp and Square, it has migrated into the preferred model of US SaaS players seeking to get more involved in payments. When looking at partnering with PayFacs acquirers have typically had to choose between four unpalatable alternatives:

1. Sponsoring PayFacs as they expand, taking pretty thin margins and dealing with the additional risk and (regulatory and card scheme) compliance burdens the PayFac models bring
2. Partnering via a referral model or white label arrangement using the PayFac’s infrastructure
3. Competing head-on with their own in-house service offering targeting the same micro/SMB groups
4. Ignoring them and hoping that regulators and/or card schemes will control in their higher risk behaviour

It has been 14 years since iZettle (now part of PayPal) launched in Europe as one of the first PayFacs, and I think even the most truculent acquirers have had to admit that:

1. Sponsoring has proved a nightmare for many traditional acquirers who experimented with the models from a risk, commercial, technical and compliance perspective, leading most to exit
2. Partnering has fed the success of competitors’ models (there are now over 350 in Europe) and accelerated the long-term decline in traditional acquirers’ market shares
3. Competing has not proven viable with incumbent cost bases, engineering resources and risk cultures resulting in acquirers shuttering their operations.
4. Ignoring the issue has not worked as card schemes have gradually relaxed rules around PayFacs, rather then tightened them

So what now for more traditional acquirers as they seek to defend their SMB relationships? Just give up? Keep slicing their own throats by reducing prices to compete? Well, perhaps the French banks may just have found the answer…! A number of the French banks have either bought, or have set up their own internal PayFacs. BPCE for example owns PayPlug while CreditMutuel has Paysurf to target more complex use cases such as marketplaces, and La Banque Postal has ezyness.

So – how does the model work? The internal PayFac (iPF) prospects for SMB clients in the open market like any other player. SMBs who approach the sponsor/owner acquiring bank are referred to, and onboarded with, the iPF. The iPF can also prospect the bank’s backbook with joint offers. Effectively the iPF acts as a specialist SMB acquiring sales and support function for the traditional acquirer in a similar way to some of the traditional JVs which flourished in Europe and the US during the 90’s and early 2000’s.

What are the benefits of the iPF model to the sponsoring “parent” acquirer bank?

• Allows the bank to retain the full acquiring role and Visa/Mastercard relationship ownership
• Enables the bank to make a compelling self-service offers to smaller merchants using a lower cost base which allows the group to generate a more attractive margin
• Enables the bank to make compelling tech-forward offers in emerging distribution channels such as embedded finance and SaaS which they cannot provide using their legacy infrastructure
• Can provide a new technical “front door” and sales engine for other bank services such as BaaS and embedded lending (akin to an internal orchestration layer)
• Creates an independent gateway/acquiring tech stack that can attract and retain innovative engineers who may not want to work in a frustrating trad-bank environment
• The bank can manage its overall risk by setting risk guide-rails (e.g. prohibited sectors) within which the PayFac can operate. In Europe the PayFac would hold its own PI/EM license and therefore can run its own AML/KYC policies. This allows them to be much more dynamic/nimble in their approach to compliance as well as commercials risk
• Possibility to use the vehicle outside Europe (where the role is typically not regulated) to provide localised acquiring with a local partner which can be very attractive to eCommerce merchants looking to localise their acquiring contracts
• Leaves enterprise merchant relationships with the parent & current contracts unaffected
• Retains relationship (and data) of smaller merchants within the bank to cross sell other core bank services e.g. lending, FX

So is this a credible option? The evidence from France is that it seems to be working despite the ongoing tensions between parents and their offspring. It is also a model which we have seen springing up in other markets such as Turkey. However, setting up a iPF is not without its own risks and effort:

• Most importantly risk committees and compliance bodies need to feel comfortable utilising a more arm’s length customer relationship.
• The technology stack needs to be digitally native and operate within a very different model to the bank’s other systems.
• Finally, it is probably easier to buy than build, but the multiples that these gateway/acquirers command can move them out of the reach of many bank investment committees.

Despite these challenges, traditional acquirers are running out of options and the iPF may just be worth one last roll of the dice to retain their SMB books in the medium term. The model can also provide a credible solution to emerging revenue generating models such as embedded finance which may secure the position of more traditional players in the longer term. It’s certainly worth careful consideration!