On Wednesday, the Financial Times editorialized that growing payment-service consolidation poses systemic risk; on Monday, we showed you how FSOC could respond, action we think increasingly likely as the Fed gets more and more spooked by critical-infrastructure risk outside its reach.  Although markets are bullish on this sector’s most recent acquisition (FIS/Worldpay), the consolidation efficiencies the market favors are seen as oligopolies by more and more bankers fearful that two few core-service providers concentrates too much risk in too few hands.  I think the Fed hears bankers loud and clear, and has a few worries of its own adding to the systemic mix.

Although core payment processors are little known outside the interstices of day-to-day retail finance, bank regulators have long recognized that companies such as FIS and Fiserv (which just bought another huge player, First Data) are critical to the everyday ebb and flow of transactions across the U.S. and, now, global economy.  One reason these firms are growing as fast as they are is that customers are using non-cash payment instruments in ever greater volume — cash as a percentage of total U.S. payments fell 25 percent from just 2012 to 2017.  Since this data only ran through 2017, the switch is surely still more dramatic, doubtless why these companies make so much of this transformation when they defend their deals, not to mention why the Fed studies payment-system transformation so carefully in the reports from which the above data are taken. 

The operational risk embedded in these companies is significant – indeed, it’s systemic – because even a small systems glitch could take the kind of chaos seen when just one big bank goes dark to turn it into a threat to the broader flow of commerce in ways that threaten merchants big and small, not to mention the customers hoping to make purchases from them.  A cyber-attack or other profound outage would have devastating effects not only to physical commerce, but also to the huge infrastructure of online retailing for which these payment-service companies are essential links.

The exponential change of U.S. payments from cash to cards and phones is presaged in other nations where cash is still less crucial.  Since these U.S. payment companies power many global payments, they are also critical to global financial infrastructure and its stability.

And, as payments get faster, cash gets still less crucial and payment-system operational and liquidity risk ramps up to still higher levels.  One reason the Fed thinks that it should run the U.S. real-time retail payment system just as it runs most of the rest of it is that, in a pinch, the central bank should be able to step in.  All of this might make sense if the payment system were still an interbank one and the infrastructure truly accessible to the Fed by way of its third-party vendor supervisory powers.  However, big payment-service companies linked to big-tech platform companies with or without interbank interfaces via traditional cards transforms the Fed’s faster-payment vision into one in which it might own and operate a system on behalf of companies over which it holds little sway but for which it takes large risks. 

Historically, the U.S. payment system is premised on banks as the consumer- and merchant-facing ports of entry and exit, with this power now shared in increasingly-uncomfortable ways with the card companies the banks once owned.  In a worst-case scenario, a payment-service company failure could be handled by the banks, at least for a while, without systemic impact because there were a lot of banks and a lot of payment companies.  In systemic-speak, there was a lot of substitutability.  Now, not so much.

Where does FSOC fit in?  Public attention has been transfixed by the Council’s proposed consignment of SIFI designation to the dustbin in favor of limited attention to the risks posed by big- or shadow-bank activities. 

Overlooked in all of the conversation over SIFI deregulation is the fact that FSOC stood by its designation and activity-practice powers for financial-market utilities (FMUs). Treasury notably ended this systemic framework in its 2017 review.  Importantly, it give the Fed far greater scope to demand governance standards from FMUs than Dodd-Frank allowed when it came to nonbank SIFIs.

What might FSOC and the Fed do with these systemic powers in the face of payment-service consolidation?  First, they could simply designate the merged firms as FMUs as has already been done for The Clearing House, the private-sector lynchpin for interbank clearing and settlement.  This would be a game-changer for these companies, as any Fed-examined entity will attest.  It’s notable that FSOC designated TCH even though The Clearing House has been in operation since 1853 and all of its owners are already under the Fed’s thumb. 

The new payment-service conglomerates increasingly play as much of a role as TCH without the legacy structure that reduces intra-corporate confusions and system conflicts.  As noted, the banking agencies have indirect authority over these companies as vendors, but this authority is split among the three federal agencies and complicated by the complex interaction of third-party payment processors with all the customization every bank of size adds to the third-party infrastructure.  Small banks don’t do all this customization, but they have complained so bitterly about punitive volume-based pricing structures that the American Bankers Association has taken the unusual step of investing in a payment-service venture.

And, of course, these deals come at a time of growing worry about tech concentration in the antitrust community.  A year ago, deals such as FIS/Worldpay would have garnered scant antitrust attention.  However, as discussed in our recent big-tech paper, concentration at the core of the payment-processing infrastructure poses significant resilience and even equality risks.  If small banks view these companies as oligopolies, the Fed finds them frightening, and the public wants a tougher stand on sectoral concentration — and they do — then core-processing consolidation faces strategic risks never seen before in this cozy, but critical, corner of the global financial infrastructure.