These comments represent the opinions of the author, and no formal or official position is evidenced herein.

1. Does the lack of a safe and widespread electronic payment system hamper the growth of electronic commerce?

Electronic commerce is growing fast. However, previous estimates of the rate of growth of electronic commerce have been over-optimistic.

Is this because these estimates were based on certain questionable assumptions regarding consumers and firm behaviour?

Rates of growth are not so much over-optimistic, as subject to wide variance.

The process is so complex that growth cannot be more than 2 or 3 fold each year. Indeed, given the complexity of the changes being wrought - the replacement of the retail market structure - such growth should be considered exceptional compared to other innovations.

Are existing, conventional methods of payment adequate for the purposes of electronic commerce?

Credit card payments are suitable for retail purchasing, and arguably, no other system is clearly superior. Where they fail badly is the lack of access to them by small companies.

Credit card payments do not work well with Business to Business, the other large sector of electronic commerce. However, in that sector, traditional transfers, initiated over the Internet from account to account are more viable, for various reasons, than electronic money systems or credit cards.

What is the role played by firm and customer awareness of risks in the acceptance of both secured and unsecured methods of payment?

Any payment system succeeds based on its reputation for making payments. Customers and firms are more aggressive with payment systems than they are with any other product, carefully analysing the record of success before committing funds. Experience shows that users participate in a very small way, building up faith slowly over time, and that regression to alternate methods is a ready response to a lost transaction.

How a payment system shares risk with the consumer is critical to its success or otherwise, directly deriving such measures as consumer confidence in a system. Payment systems such as the credit cards manage to build consumer confidence by ensuring that transactions can be backed out. In contrast to the security of credit card use, proposed electronic cash systems indicate to the user that funds can be lost if the user is not careful.

This is not a good consumer proposition, and experience to date has shown that consumers are canny enough to treat the risks with appropriate levels of caution. Electronic cash systems need to demonstrate a sufficiently higher level of utility to overcome this, and have thus far failed to do so.

With electronic cash, consumers have bought, spent and got out in droves. Dissatisfied, consumers have voted against the system. It is a mystery to this author what any regulator can add to this equation, as it appears that consumer trials have shown more efficacy in regulation than any committee can.

Regulators can not solve the market equations presented by the new mathematics of Internet payment systems, but consumers can. They do this using information made available by the operator, and by reputation that is generated by successful transactions.

What are the prevailing criteria for the adoption of various cost-effectiveness and safety levels currently achievable by available and emerging payment systems?

Several techniques have arisen, none of which are fundamentally new.

1. Escrow of funds with third party signatories from reputable partnerships.
2. Separation of concerns within the organisation.
3. Separation of day-to-day funds from major reserves.
4. External audits on a regular basis.
5. Publication of total float and reserve amounts.
6. Public monitoring of special balance sheet accounts.

Experience has shown that these solutions arise simply on the basis of customer queries and accountancy advice. This should be no surprise, as they are covered liberally in management and accountancy books.

As a rough estimate, a system with 100,000 Euros under management might start to think about some of the above techniques; a system with 1,000,000 Euros under management might be preparing plans for most or all of the above. Admittedly, there have been insufficient numbers of small systems to state these numbers, and evidence must remain anecdotal.

Does the rapid diffusion of electronic commerce depend largely on unresolved safety and regulatory issues?

No, the major impediment is within the merchant companies and their service providers.

Whilst it is acknowledged that ambiguous and inconstant viewpoints from European regulators have reduced enthusiasm from innovators working on payment systems, this author does not consider such to be an impediment to electronic commerce.

Are there any other important barriers and drivers, which could be identified in the deployment of electronic commerce?

Growth in electronic commerce is limited by a number of factors.

In general, the biggest impediment to the deployment of ecommerce is the overall complexity of the retail transaction and the consequent work load and learning process imposed on the retailer.

Retail purchasing is an extremely difficult problem, and is miscast as an application; in reality, it is many thousands of applications, each being architectured for the individual retailer. This makes the process very costly, as little of the work that has been done at one site is then re-useable at the next.

The complexity impediment is universal, and does not effect European electronic commerce any more than any where else. If we were to limit ourselves to European barriers the following particular limitations are observed:

• The lack of widespread cryptography tools, as installed on user platforms and within user applications. This is due to US trade barriers which create a differential in security between the US installations and software and those outside the US. Electronic commerce only functions with strong security, and complete systems of this nature are not exportable to retailers outside of the US.
• The Euro. Big projects such as the Euro and Y2K effect will drain programming talent from e-commerce for the next 2 years.
• Access to credit card processing by small companies. Many small companies are barred from access to payment mechanisms due to size, credit ratings, cost or short lifetime. As most innovation in Internet commerce occurs amongst small companies, this effect is traumatic.

This question relates to the previous one, but focuses more on cross-border payments on the Internet.

What is known about the current size of cross-border payments?

This author has no information on the current size of cross-border payments.

Has the lack of a common currency been a major constraint on the development of cross-border electronic commerce?

No, as the major payment mechanism for electronic commerce is credit cards, there is no strong effect from the currency difference. Where there is an effect is in the lack of harmonisation in credit checking and delivery mechanisms. However, this is not so much of a problem as might be imagined.

In European terms, borders policies with respect to goods and services are a major barrier, far in excess of the effect on retail trade when conducted with credit cards. Since the dropping of internal customs barriers, intra-community electronic commerce is boosted significantly, mostly at the expense of extra-community electronic commerce.

This, of course, was the intention. At each border, there occurs delay, direct customs cost and a potential for loss. This has generally resulted in 20% or more in additional costs to the consumer, which is huge in comparison to the fee charged by credit cards for automatic currency conversion.

Will the introduction of the Euro, consequently lead to a surge of such commerce?

In this author's opinion, the introduction of the Euro will have little positive effect on electronic commerce. Perhaps the upside will be that users will be able to purchase in a single price, but in general this is less of a problem than expected, as sites can easily post prices in multiple currencies.

Where the Euro (already) has a significant effect on electronic commerce within Europe itself is the drain on available programming and managerial talent within retail and finance sectors in general. Coupled with the Y2K issue, there is a significant shortage of computing skills which will last for the next 2 years or so. This results in increased competition, and inevitably, electronic commerce projects by European firms will suffer.

In particular, for which types of products and services do you expect cross-border electronic commerce to increase?

The necessity for the standardisation of electronic payment systems cannot be taken for granted. If electronic payment follows the "credit-card model" it might be expected that several payment systems could co-exist.

How likely is such a scenario and what costs does non-standardisation entail for consumers, firms and regulators?

In the short to medium term, the credit-card, as a basis for Internet payment systems, will dominate. In the longer term it is not clear in which direction payment systems will head.

The suggestion that non-standardisation will result in increased (net) costs to the consumer is highly disputable, especially if accompanied by regulatory pressures that lead to monopoly systems.

The payment systems business is inherently two-faced; on the one face, the effects of network externalities, the increase in the utility according to the square of the members, implies that the most efficient payment system is one that is universal. On the other face, no payment system can provide for all the needs of the user, and thus, network benefits are limited by the capabilities of the system itself.

This results in an oligopoly structure of a few large payment systems. For example, cheques, cash and giros all compete with credit cards, in different ways and at different times, for the attention of users.

Once this situation of competition is recognised, it makes less sense to discuss consumer improvement at a regulatory level. After all, how can a regulator improve on the competition between cheques and credit cards, when the proponents of both have every incentive to make their product more attractive?

Equally, the issue of standardisation of Internet payment systems is not something that can be currently considered from outside. The answers to many questions are far from clear, and at this stage of experimentation, there is no chance of even the insiders agreeing on what, where, and how makes a good Internet payment system.

4. Should markets or regulators impose future standards – if necessary – for electronic payment systems?

Standardisation might either, evolve from market forces or, be imposed by regulators. Given existing market imperfections, there is no guarantee that market forces will produce the most efficient outcome. On the other hand, imposing standardisation by regulators runs the risk of stifling innovation in this field. Moreover, if international regulators fail to co-operate, it could lead to a fragmentation of markets.

There are many difficulties with imposing standardisation or regulation in this field.

The obvious difficulties with the Internet are the absence of physical control that might be exerted by any erstwhile regulator. In other fields of commerce, certain assumptions were valid that made regulation plausible.

Chief amongst these was the assumption that the target of regulation was national, in that any commercial endevour tended be characterised as belonging to one country or another. This strong segmentation derived partly from the cultural forces at work - the user base tended to be of one nation and one language - and partly physical ones - in that to reach any user base, one tended to need a bricks and mortar presence.

With such a situation it is easy to standardise, or regulate, on national lines. With the Internet, no such assumption exists. Indeed, it is completely the opposite, in that the Internet encompasses all nations and cultures, but permits none to dominate. Virtual assets such as brand stand out where conventional assets such as bricks and mortar fail to entice.

Without a territorial basis for standardisation, or regulation, any attempt is fraught with difficulties. If a level-playing field is achieved by limiting the activities of national players, one player need only set up across the border to escape the limitations.

Or, more likely, successful companies from the United States will set up franchises within or without Europe. These franchises will be tailored to escape the barriers applicable to the locals, and will build on the success of their Internet brand already established in the US.

Such a process is already well-underway within the securities trading industry. Slow-paced locals, limited fundamentally by competition-avoiding regulators, have little answer to the speed with which companies like E$TRADE can encroach on previously protected markets.

Internal barriers move innovation outside. This leads one inevitably towards a lowest-common-denominator approach to regulation, or further. The problem with a lowest-common-denominator approach is that it pleases no-one; the alternate is to have no regulation whatsoever. This approach, whilst radical, has much to recommend it:

• Consumers chose and use financial products primarily on the basis of personal recommendations and brand, not on the existance of regulation or otherwise. This can be seen most clearly where there are differing levels of regulation available, such as between the UK and her various offshore jurisdictions.
• Brand itself becomes a dominant strategy, and an unregulated branch of, for example, Barclays Bank in Jersey, would be under more strict regulation from its head office in London than could ever be provided by local bureaucrats. The thought of a scandal that could damage the brand would fill shareholders with more trepidation than any comment by a central banker.
• In a confusing world, the first resort for information is from personal recommendations. This provides an immense barrier for any financial services provider, in that a body of goodwill must be built up before any success can be achieved.

On the Internet, consumers can look after themselves, and do so, on a daily basis. There is little validity in regulating electronic payment systems from a consumer protection objective, as the community of Internet consumers has shown itself to be more capable than a regulator in this task.

In such circumstances, the more appropriate question is how to help the new payment system provider to gain the confidence of the Internet community, rather than to limit them with regulations that do not really get at the nub of Internet and payment systems problems.

In this respect, European regulators have hindered the development of electronic money. Indigenous providers have looked at ambiguous statements as to who can operate payment systems, and what regulation applies. Innovative firms across Europe have looked at the series of reports, comments and proposed directives, and have concluded that there is a high likelihood of interference with a successful business. To enter the business of payment systems means to risk having any success transferred to the regulated institutions under fire-sale circumstances.

Are there any past examples of technological standardisation, which could serve as models for the development of interoperability standards for electronic payment systems in Europe, and on a global scale?

However, it should be stressed that in the view of this author, there is no case for standardisation at such an early point in the development and trial of systems.

5. How to regulate issuers of electronic money?

Of the various rules that have been proposed, the most regressive of all is the rule that limits electronic money issuance to the banks, or similar regulated financial institutions.

There are many reasons for this, and the following is only scant evidence of the public failure inherent in current proposals.

Banks are the wrong companies to operate electronic money systems.

1. Firstly, banks are concerned with banking, which is the taking of deposits from the public, and the making of loans to the public. By their nature, these loans are risky, and thus the nature of banking is very much the balancing of risks against liabilities.

   This characteristic is directly contrary to the spirit of new payment systems, which by means of 100% reserves and real time gross settlement (RTGS), strive to eliminate risk from the system.

   We can see this contrast by examining balance sheets. The balance sheet of a bank is a complex affair, and does not begin to describe the true state of affairs. Only by complex analysis of the term structure of interest rates and the loan portfolio is it possible to form a viewpoint of a bank's financial health.

   In contrast, the balance sheet of a payment system is simple, clean, and complete in its picture. It can only become messy, risky and convoluted by acts of poor management, by poor regulation, or by being merged with the balance sheet of a bank.

2. Secondly, banks have no ability to innovate. This unfortunate fact derives from the overbearing regulation that banks operate under, which results in an unwillingness to deviate from that which is commonly accepted practice within the banking community. This conservatism results in clustering, the apparent similarity of one bank to the next.

   Whilst generally not an issue, bank clustering does imply that innovation is not to be expected from this segment. A bank will only slowly adopt innovations from outside the industry (although once one has adopted, the rest follow quickly).

3. Thirdly, banks are not competitive, and a requirement for the development of new payment systems is a competitive trial by fire, as it were. No system of such complexity will arise if it cannot stand on its own merits.
4. Fourthly, banks are not good marketeers, and it would appear that the success of any payment system will be more to do with the marketing equation than the technical details.
5. Finally, banks are simply too large to participate in complex Internet projects. This appears to be the result of two factors: that the architecture of any system is captured by the many special interests that pervade the banking world, and that the projects operated by banks appear to be too big and unwieldly to cope with Internet time and knowledge.

In conclusion, to limit payment systems to banks will limit payment systems to weak systems that are forced on unwilling bankers.

Which rules should be imposed upon issuers of electronic money and who should monitor them?

This author believes the following to be sufficient:

• That all public disclosure by Issuers should be factual.
• That Issuers of electronic money are subject to normal remedy under law. That is, they get no special dispensation, nor are they subject to special requirements.

In addition to the above, this author advises Issuers to do the following:

• Reserves are escrowed with third parties that specialise in the safe-keeping of funds.
• Reputable parties, such as internationally known partnerships in law or accounting, be placed in charge of major escrowed monies.
• The total reserves should be publically stated over the Internet, by means of account balances. (This may require some sophistication on the part of institutions that escrow funds for Issuers.)
• The total float of a currency should be publically stated over the Internet.
• Individual accounts that are used for escrow, monetary creation, and internal treasury functions, should be publically scrutinisable over the Internet.

  Indeed, the above accounts and totals should be presented as a balance sheet for the Issue.

• A clear process for remedy of dispute should be described for the consumer. Such a process would rarely involve resort to courts as neither Issuer nor consumer can afford such activities in the low-margin business of payment systems.

Are the current proposals of the European Commission a sufficient answer to the need to regulate issuers of electronic money?

The current proposed directive, as listed in Proposal of late 1998, provides a useful document for discussion. However, there are a number of shortfalls:

• There are substantial gaps in the definition (forms of money, nature of balance sheet).
• Little is said about public disclosure, the only potential guard against failure, in the opinion of this author.

  This comment is useful for its recognition of a contract and terms:

  The contract between the issuer and the user shall define if the stored electronic money is redeemable or not, and, if appropriate, the conditions, the formalities and the time period of redeemability.

  yet its inclusion without further comment on, for example, financial liabilities, appears to be an afterthough. It may be that such comment is deferred, as intimated by action (ii) (Consumer issues, Explanatory Note).
• An undiscussed liability is incurred by "competent authorities" in pursuit of their responsibilities. As the existance of effective directives and supervision will be interpreted by consumers with wide latitude, there is some concern as to a lack of statement of failure conditions.
• Aside from gaps in the definition of electronic money, it is not clear what relationship this directive would have towards the regulation of payment systems in general.

  That is, there should reasonably be expected to be some convergance in approach between Internet money and something similar such as, hypothetically, syndicated casino chips or paper-based loyalty tokens. For further example, does this directive pressage the opening of the way for Issuers of paper money?

• The directive would appear to be premature, in that this author is unclear as to which current situation the content is designed for. (This may however be a necessary first step in order to clear up the current unacceptable and ambiguous situation with respect to non-regulated Issuers.)
• The obligation on capital and funds is either unclear or discriminatory, as, in the opinion of this author, approximately half of the interesting work has been done by firms that would not qualify.
• The process of promulgating this directive is subject to a number of vagueries such as the length and legalise of the document, the number of referenced prior directives, the uncertainty of effect and timing of any national legislation, and the overall climate of debate on the subject. Given, especially, the widespread disagreement amongst authorities within Europe on this issue, only cautious support is likely.

• Electronic money is likely to be a very small component of total money for the foreseeable future.
• Electronic money, like all other derivative forms of money, requires a chain of redemption back to high-powered money. This high-powered money is generally the direct target of monetary policy, and thus electronic money does not escape the effects any more than other forms of derivative money.
• Monetary policy would appear to have more to be concerned about from other areas, including evidence of its weakening due to increasing innovation in the financial system, and also evidence of the inefficacy of monetary policy for its own purposes.

It would appear that some regulators believe that mention of monetary policy is sufficient to lay claim to jurisdiction. This is challengeable for several reasons, as listed throughout these comments, and this author suggests that mention of monetary policy be accompanied by clear description of how it is endangered by the existance of electronic money.

In contrast, electronic money is highly sensitive to monetary policy, as its use is likely to be dictated by discretionary monies for the foreseeable future. As discretionary funds are the first to rise or fall due to policy changes, electronic money is likely to be at the vanguard of changes to policy.

In other words, electronic money has much to fear from monetary policy, and not the other way around.

The widespread use of electronic money could affect the stability of money demand. This would further diminish the relevance of monetary aggregates as guides for monetary policy making. Another possible effect of the widespread use of electronic money is a smaller demand for central bank money by commercial banks. As a consequence, it would be harder for central banks to steer the money market.

Money demand derives from the users of money, not the payments systems that are in operation. If there is a supply shortage that increases demand for electronic money, this will also increase demand for all other payment media.

Demand for money very quickly spills across different media, as people seek methods to pay for the trade. This is simply money demonstrating its efficiency, its ability to avoid barter.

If indeed there is rampant support for electronic money because supply is constrained elsewhere, then this is evidence of the weakness of the tool of supply constraint. Such causality should be interpreted as a sign to seek other tools at the least, or as a general weakening of monetary policy at the most. It does not in any way support calls for regulation over one payment system or another, as to do such simply shift the attention of users to systems that remain unregulated.

Additionally, lesser demands being made on central bank money is evidence of increasing efficiency in the financial system, and if this is attributed to electronic money in any way, then it is only as an additional benefit to the other forms of moneys that have also improved the financial system. To consider an improved efficiency as a threat is to put the cart before the horse.

There have been several solutions proposed on how central banks should cope with these problems. If electronic money is only a substitute for "official" money, central banks could simply widen the definition of their monetary aggregates to include electronic money. As the most far-reaching way to secure its grip on the money market, the central bank could impose reserve requirements on electronic money balances. The above raises several questions:

How likely is the widespread use of electronic money?

The widespread use of electronic money is limited by the current lack of applications. Today, the application that has seen the widest exposure is that of retail purchasing. In this case, the difficulties of developing robust systems for this application have mitigated against electronic money systems. The lowest common denominator effect has resulted in credit card systems predominating.

Until new applications are fielded that use electronic money in a way that lifts it above the limitations of credit card payments, there will be no widespread use of electronic money. (User-to-user payments is not such an application, and this author generally refers to such as a feature.)

Can e-money be considered as a new "type" of money?

E-money can be considered as a new type of money, along with credit cards, cheques, accounts, cash, giros and money orders.

Will it be limited to small amounts?

No. In fact, the more compelling applications for e-money are aimed at medium amounts: ones where the values at stake justify the additional expense, but where cost is still an overall constraint.

Small amounts make little sense at the moment, as all systems so far proposed impose large setup costs for user and provider. Large amounts are also unlikely to be in the vanguard, as potential providers of these systems are too conservative to trust such amounts to untested technology.

For the sake of discussion, medium amounts can be considered to be from 100 Euros to 10,000 Euros.

Will it only be a substitute for "official" money?

There is no reason why e-money cannot be used for official purposes, and likewise, there is no inescapable reason why e-money, or government issued money, should be any better than any other form.

Each form of money succeeds on its own merits. The only circumstance when a form of money succeeds beyond its merits is when a government legislates conditions of monopoly. Such conditions have generally existed for notes and coins since the turn of the century, and it is therefore not possible to make a fair comparison between the success of notes and coins and any other competitive system.

E-money will compete with other forms, on a playing field that is not level due to incumbents and regulations. If it succeeds, and manages to secure a place against the best efforts of its opponents, then it is clear evidence of the discovery of new efficiencies in the financial system.

So far, such success has not happened, so the evidence is not strong. This does not mean that the counter-claim is true, as it is clear that the barriers into the payments systems business are far too strong to permit fair comparisons of success.

In summary, there is no particular reason for e-money to be constrained to any segment of usage, and no reason to believe it will "supplant official money." It will be used where it makes sense. Such considerations apply equally to all money types.

Over what volume would the replacement of "official" money by e-money represent a threat for monetary policy?

None, where statal units are used. E-money which is denominated in statal units has a chain of redemption back to high-powered money and is thus highly sensitive to monetary policy, regardless of the volume.

Where e-money might reduce its current extreme sensitivity to monetary policy is in the denomination and contract redemption in other instruments than statal units. For example, e-money denominated in shares, indices, and commodities will then inherit the relationship from those instruments. Shares are somewhat effected by monetary policy, whereas commodities are mostly un-correlated.

Are the measures proposed to secure the central banks grip on the money market sufficient?

No. There is nothing that central banks can do that will secure a "grip" on electronic money. The best that they can do is to ensure that their own citizens and companies do not have free access, and that their own companies do not participate in the supply of such technologies.

There is sufficient empirical evidence with new Internet money schemes to indicate that success will be of an international nature. The choice of jurisdiction appears to have only an indirect effect on the success of schemes. Although there is a user popularity for local jurisdiction, this by no means limits the user base of any scheme that has demonstrated even marginal success.

Internet money is something that appears to not respond well to regulation. The experience appears to be, at this early stage of experimentation, that adding regulational and jurisdictional issues to an otherwise difficult project pushes it into the intractable.

What are the costs of these measures?

The slowing down of the delivery of Internet benefits to companies and individuals. At some stage, some countries will deliver benefits according to successful trials and projects. If any measures proposed are contrary to the architecture of successful projects, then these benefits will be lost to those countries that pass premature legislation.

Should electronic money affect monetary policy-making, what kind of measures would allow the central bank to keep control on the money market?

If electronic money becomes an important form of exchange, then it will include many of the features that are present with other parts of the financial system. For example, capital markets will exist with loan and equity instruments managed with the technology of Internet money.

Central banks will be at liberty to conduct open market operations within their statal currencies. That is, treasury issues of debt instruments can be used to set interest rate policy, or exchange rate policy, as desired. Overnight rates can be set for Internet funds on short term deposit, just as they are with account money.

Respondant Contact:

Ian Grigg, Systemics Ltd. email: iang@systemics.com

EC Contact:

Dr. Demosthenes Papameletiou, European Commission, Joint Research Centre, IPTS, Tel.: +34. 95. 448 8289; Fax: +34. 95. 44 83 26; e-mail: demosthenes.papameletiou@jrc.es

Dr. Michael Rader, ESTO/ITAS, Tel.: +49. 7247. 82 2505; Fax: +49. 7247. 82 4806; e-mail: rader@itas.fzk.de