Although we could argue that the traditional merchant acquiring industry has not seen major disruptions recently, we cannot ignore the global rise of the so-called Payment Facilitator model. Edgar, Dunn & Company felt it was important to share our observations and look at this subject in a mini-series of articles in our monthly newsletter. In this first introductory piece, Volker Schloenvoigt (Principal, London) and Shanta Paratian (Manager, London) describe and define the basics, as well as the role of the Payment Facilitator, and the requirements to become one.
The merchant acquiring industry has, arguably, not seen significant disruptions in the traditional set-up whereby a merchant acquirer provides the typical value-chain functionalities to enable offline and online merchants to accept electronic payments. Yes, acquirers are stepping up their efforts and offering new value-added services. Yes, the importance of omnichannel capabilities as well as alternative payment methods is growing. And yes, on the POS terminal side, there is a gradual shift from hardware to software solutions. But the role of the merchant acquirer and its contractual relationship with the merchant has not changed fundamentally for many years.
Nonetheless, if you have followed the industry, you would have seen more and more references to the so-called Payment Facilitator model (or PayFac). It is a set-up that has become much more prevalent in recent years. Infinicept, one of the specialist providers in this space, has monitored the number of registered PayFacs globally. In 2018, there were already 966 PayFacs and this is expected to increase to 1,500 by the end of 2021. According to Infinicept, this would equate to revenues for PayFacs of approx. $5bn in 2021.
We, at Edgar, Dunn & Company, are also discussing this model more and more frequently with clients and we felt it was important to share our observations and look at this subject in a mini-series of articles in our monthly newsletter. In this first introductory piece, we describe and define the basics, as well as the role of the Payment Facilitator, and the requirements to become one.
Let’s start with a definition and some context for why this model emerged.
We would define a Payment Facilitator (or a master merchant) as an alternative to the traditional merchant acquirer that is focused on serving small and micro-merchants (in the PayFac model also known as sub-merchants) in the e-commerce environment. Well before COVID-19, these smaller merchants increasingly wanted to engage in e-commerce activity and for a number of years, merchant acquirers have been struggling to manage the on-boarding and credit risk assessment for this large number of small merchants efficiently.
The Payment Facilitator sits in the middle between the sub-merchant and acquirer and ‘facilitates’ speedy onboarding and setting up of the merchant account in a more efficient manner. Because it does this on behalf of the acquirer, it is important to recognise the contractual relationships between the different entities:
- Not everyone can be a PayFac – a PayFac needs to have a sponsor and therefore has a contractual relationship and a master Merchant Identification Number (MID) account with an acquirer that is licensed by the international payment schemes. As part of this contract, it will, for example, be defined in which geographic jurisdiction the PayFac can operate. Note: payment schemes provide a list of registered PayFacs on their website and this is a good source for an overview of PSPs, software companies, etc. that have become a PayFac in recent years
- The merchant only has a contract with the PayFac and has no direct relationship with the acquirer. Technically speaking, the PayFac is the Merchant of Record with one Merchant ID, whilst the individual merchants run as sub-merchants under that PayFac’s master account.
From a processing perspective, the acquirer receives funds from the issuer and pays them into the master merchant account of the PayFac. The PayFac controls the flow of funds, splits those as appropriate, and pays out funds directly into the applicable sub-merchant account of the individual merchant.
In order to perform these activities, a PayFac needs to have a number of distinct capabilities. Without going into too much detail, there are four key aspects that a PayFac needs to be able to support:
- Risk Underwriting and Onboarding – the PayFac is responsible for conducting a due-diligence of the sub-merchants and setting up the appropriate onboarding process. As transactions can all be aggregated under a single PayFac’s Merchant ID, it is critical for the PayFac to follow KYC practices properly and assess the financial health of each sub-merchant correctly
- Merchant / Transaction Monitoring – once the sub-merchant has been onboarded, the PayFac is responsible for controlling that all payments adhere to the scheme rules and that it is in a position to track and identify suspicious transactional activity quickly. Monitoring sub-merchants’ activities on an on-going basis is therefore essential. Also, it is worth pointing out that schemes have a threshold for the annual turnover of sub-merchants. If a sub-merchant exceeds such threshold, it is required to enter into a direct merchant agreement with an acquirer. There are regional differences regarding these threshold rules. In the US, Visa has set this threshold at $1m turnover per year whereas in other regions a limit of $100,000 per annum applies.
- Pay-outs / Funding of sub-merchant accounts – as briefly mentioned earlier, as this includes the pay-out to the sub-merchant account, additional fraud and risk management capabilities are required (e.g. preventing fraudulent activities, monitoring credit risks, anti-money laundering, reputational risks, etc.). PayFacs will also need to be PCI compliant.
- Chargeback Management – PayFacs are also responsible for the chargeback management. They manage the whole process together with the acquiring bank. This will include providing documentation support, whilst at the same time, PayFacs will need to set processes in place to prevent any loss liability from excessive chargeback ratios.
Becoming a PayFac requires being able to support these key capabilities. In addition, prospective PayFacs will need to find an acquirer that acts as the sponsor, registers the PayFac with the payment schemes, and provides the merchant account for the deposits. The PayFac will have to demonstrate its financial viability and provide a business plan to the sponsor.
The PayFac model clearly provides a framework that works for all stakeholders involved: sub-merchants benefit from a much speedier onboarding process and can activate their online business at a quicker pace, acquirers manage to ‘outsource’ the onboarding and monitoring activities and risks of smaller merchants to the PayFac, and the PayFac profits from a much stronger and stickier merchant relationship as well as being able to increase revenues, rather than playing the role of an ISO only.
In next month’s article, we will explore this topic from the PayFac’s enabler or the sponsor’s point of view.
The content of this article does not reflect the official opinion of Edgar, Dunn & Company. The information and views expressed in this publication belong solely to the author(s).