The Green Sheet Online Edition
March 27, 2017 • Issue 17:03:02
A legal take on the rise of legitimate aggregation
It used to be unacceptable to process transactions for multiple merchants through a single account; now everyone is doing it with payment facilitators (payfacs) and payment service providers. In this article, I'll discuss legal issues pertaining to this new, legitimate form of aggregation, which a number of payfacs consider or use as a solution for the payments element of their business ideas.
What is a payfac?
A payfac is a relatively new form of registration with the payment networks that allows an entity to acquire payment card transactions for multiple sub-merchants through a single master merchant account. In plain English, a payfac has its own merchant account that it can use to process transactions for multiple merchants. Those merchants are often called sub-merchants, each of which has a separate merchant identification number. Merchants who reach $100,000 in processing volume are no longer aggregated and become direct merchants with acquirers.
Advantages of payfacs
Payfacs enjoy certain advantages:
- Speed: If you are not a payfac, boarding a merchant involves collecting certain information concerning the merchant and then waiting for the acquirer's underwriting department to approve the account. Once the account is approved, it must be activated, and the merchant has to go through the necessary integrations to go live. This takes time.
In contrast, payfacs assume the risk of fraud or other losses on merchant accounts, board merchants instantly, and sort out the details later. This provides the fastest way to get merchants live.
- Control: In contrast to a regular ISO, payfacs have greater control over boarding, pricing and risk management. Payfacs can control the settlement of funds to sub-merchants and are therefore more able to manage risk in the account.
Disadvantages of payfacs
Following are some disadvantages to the payfac model:
- KYC and AML: Being able to board sub-merchants within seconds provides significant convenience, but it also creates opportunities for money launderers and other criminals to abuse the payfac's payment rails to process fraudulent payments.
A payfac could unwittingly board hundreds of sub-merchants that are in bad faith and processing transactions unrelated to their stated field of activity. For example, a ride-sharing app that gives each driver a sub-merchant account might unintentionally process payments for an escort service.
With gateways able to route transactions quickly between countries and banks, payfacs could end up processing transactions that are not what they seem. For example, a U.S. domestic payfac serving nail salons might unknowingly illegally acquire transactions for international online gambling.
It is a best practice for payfacs to establish know your customer (KYC) and anti-money laundering (AML) programs to reduce the chances of criminal abuses. Most acquiring banks will want to review a payfac's AML program before sponsoring the payfac.
- Processing volume cap: Most payfacs eventually want to have merchants that, for the most part, are processing more than $100,000 in volume. That is, most payfacs want a portfolio of "real" merchants. Boarding a merchant as a payfac sub-merchant offers speed, but since merchants processing more than $100,000 cannot be boarded as sub- merchants, they must go through the traditional vetting process for merchant accounts, which is time consuming.
- Risk: A regular, no-liability ISO does not take liability for chargebacks, fraud and other losses caused by merchants or their customers (provided the ISO is not complicit in the wrongdoing). A payfac, on the other hand, assumes liability for chargebacks and other losses caused by merchants. Assuming that liability obligates the payfac to hire personnel who are qualified to manage merchant risk.
- Technology: Banks that sponsor payfacs expect the payfac to have its own systems that are able to capture and process data related to payfac sub-merchant transactions. This technology is very costly and serves as a barrier to entry for many payfacs. Endeavoring to solve this problem, Payrix.com provides payfacs with a turnkey solution for the technology necessary to run a payfac.
The various payfac business relationships require distinct contract terms.
- Payfac-acquirer: The contractual structure between a payfac and an acquirer is similar to that of an ISO and acquirer. There is a sponsorship agreement and a payfac agreement. The sponsorship agreement enables the payfac to be sponsored by the bank into the payment networks as a payfac. The payfac agreement between the payfac and its acquirer sets out the terms by which the acquirer will acquire payment transactions submitted by the payfac – or more specifically – its sub-merchants.
- Payfac-sub-merchant: Here is where it gets interesting. Payfacs often have a service for their sub-merchants that is separate for the payments element. Consider a payfac focused on babysitters, for example. Each babysitter gets an app through which he or she can schedule babysitting gigs and then also accept payments from their clients.
Scheduling features and other parts of the app that do not relate to payments are usually dealt with through the payfac's terms with its clients. The payments element then becomes an add-on, sometimes as an addendum to the payfac terms (that is, app terms) and sometimes as a separate stand-alone agreement. For example, at https://stripe.com/us/legal you can see the separation between Stripe's terms for its services and those of Stripe's sponsor bank, Wells Fargo & Co., for the payments terms.
Some acquirers let payfacs contract directly with sub-merchants for the payments element; others require stand-alone terms for the payments element between the acquirer and sub-merchants directly. Payfacs should know the acquirer's requirements in advance so they can plan their boarding terms and processes accordingly.
Payfacs are an excellent innovation well worth investigating, both for new fintechs and established ISOs. Visa provides useful reading on payfacs here: https://usa.visa.com/dam/VCOM/download/merchants/02-MAY-2014-Visa-Payment-FacilitatorModel.pdf.
In publishing The Green Sheet, neither the author nor the publisher is engaged in rendering legal, accounting or other professional services. If you require legal advice or other expert assistance, seek the services of a competent professional. For further information on this article, email Adam Atlas, Attorney at Law, at email@example.com or call him at 514-842-0886.
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