Loyalty Points: Legal & Regulatory Matters
If you prefer long-read reports in PDF format, here’s the link: grom.org/loyalty-legal.
This article is provided by the legal team of the Pinpon project. This is not legal advice; in case of any doubt, we encourage you to consult your lawyer. This is a very broad overview of general regulatory approaches to loyalty points; it is intended to provide initial understanding and does not substitute your own legal research.
Please note that this is an introductory-level material — if you are a lawyer and feel offended by the inaccuracies and imprecisions in this text, please forgive us; we will be glad to have a technical discussion with you.
Table of Contents
1. Background
2. Concern
3. DLT and Regulatory Fears
3.1. ICOs and Securities Regulations
3.2. Crypto and Money Flow Regulations
4. Nature of Minter and Pinpon
5. Loyalty Points and Regulations
6. Securities Regulations
6.1. USA: Securities Act and Howey Test
6.2. EU: MiFID II (Detailed Analysis & Bottom Line)
7. Money Transfer Regulations
7.1. USA: BSA
7.2. EU: PSD II (Detailed Analysis & Bottom Line)
8. Conclusion
1. Background
As you probably know, Minter is a blockchain solution that enables any brand, blogger or community to create their own coin and implement it into reward mechanics suitable for a loyalty program.
Minter is used as a technological basis for Pinpon — a one-stop brand-loyalty solution that can help design and implement a custom loyalty program, distribute loyalty points and reward your customers.
2. Concern
At Pinpon, we listen to the community, and one of the themes occasionally brought up is the question of applicable regulations. Since Pinpon is built atop the Minter ecosystem, and Minter utilises DLT solution to ensure security of the transactions, some of the users become concerned about whether there are ‘crypto’ legal issues embedded in our system.
This concern is understandable. We have all heard horror stories about SEC crackdown on TON, and we can empathise with the business owner who worries about the long-term safety of their enterprise and needs to be sure about whether the solution they plan to use is watertight from the legal point of view.
3. DLT and Regulatory Fears
The short answer to this concern is that regulators, for the most part, do not actually care what technology you are using to achieve your business goals; it is the goals themselves and the economic reality behind the actions you take to achieve those goals that can trigger regulatory response.
The general concern about the legality of everything ‘crypto’ and ‘blockchain’ can be understood because of two different yet at one point persistent problems with the decentralised solutions and people who have pioneered them. We need to take a closer look at these problems to face our fears and understand what we are afraid of, and why we are afraid of these things.
3.1. ICOs and Securities Regulations
The first problem is the reaction to the boom of barely legal financing events you may know as ICOs. Having started as a genuinely bright idea for attracting crowd finances to tech projects, ICOs soon caught the attention of scammers and outright criminals. While some have seen them as a chance to cut the red tape and avoid the burdensome regulations of more conventional financing solutions, others have used them for fraud. At some point, the governments across the globe noticed this and started taking action, applying the already existing legal rules to those who hoped to bypass them via a tech solution. Although it never reached universal scope, some tech entrepreneurs have been charged with securities fraud, which lead to the adoption of a more careful approach to the use of blockchain in financing. This is the first reason why the word ‘crypto’ can be associated with legal troubles.
3.2. Crypto and Money Flow Regulations
The second problem is connected with the first real world case of DLT — cryptocurrencies and their monetary characteristics. Every government tries to enforce control over value transfer. It is necessary from the taxation point of view (the government should know who gets the income to successfully tax them), for crime retribution (if someone gets money by committing a crime, the government needs to follow the money to find and punish them), and crime prevention (you need to prevent terrorist groups from getting money in the first place, so they would not be able to carry out their attacks). Control of money flows is serious business.
Cryptocurrencies such as Bitcoin were used to bypass this control over flow of funds, causing authorities such as FATF (Financial Action Task Force) to issue warnings about the inherent risks of crypto. For a period of time, cryptocurrencies were heavily used as a payment method in the criminal activities, leading to another reason why the word ‘crypto’ may cause one to feel unease.
These risks are being more and more mitigated in time; new anti-money-laundering regulations are introduced in most countries, creating a safe and compliant landscape to use cryptocurrencies in legitimate business schemes, and technical solutions such as blockchain network analysis are lowering the chance to successfully hide funds from the government control. At the same time, some of the blockchain solutions designed specifically for money transmission are experiencing regulatory pressure to comply with the specific laws for money transmission, such as Bank Secrecy Act in the USA or Payment Services Directive in the EU.
Having identified the main causes for concern, we can move to the really important question: Do these apply to Minter and Pinpon?
4. Nature of Minter and Pinpon
While Minter is a powerful system with many conceivable use cases, at its core it has been developed to manage loyalty programs and allow different brands to interact with one another by sharing their audiences. The instant liquidity mechanics of the Minter blockchain that allow any coin to be transformed into any other has been designed so that each customer could at any moment exchange loyalty points of one brand to those of another at the fair rate, without the need for this rate to be discovered via market mechanics.
This feature is very important from the regulatory point of view. Since the exchange of coins within Minter does not require a secondary market to operate, it helps avoid all of the regulations that could arise from it. Limitations on secondary market activities play an important role in avoiding the payment system/money transmitter qualification, which could potentially create problems for a blockchain system.
Pinpon went one step further in protecting its users from the possible legal concerns. On the technical side, Minter is a public blockchain; this means that to comply with applicable regulations, safeguards have been installed in the legal terms that bind users of the system. Pinpon, on the other hand, is implementing the compliance by design approach, providing technical limitations to the coins transfer that protects the system from triggering regulatory response.
Both Minter and Pinpon are primarily designed for loyalty programs management. It means that in applying legal analysis to their regulations, it is more productive to disregard the use of blockchain technologies in them and consider the tokens transferred within the system to be what they are from the economic point of view: loyalty points.
5. Loyalty Points and Regulations
While we all intuitively know what loyalty points are, there is surprisingly little specific regulation concerning them. This can be due to the fact that there are relatively little risks for the public involved in operating the loyalty program. Few governments will regulate economic relationships for the sake of regulation, especially where, as in the case of the loyalty programs, novelty of the solution is half the reason to implement the program in the first place.
It does not mean that loyalty programs exist in the total blankness. You should most certainly check the regulations in the following areas:
- Customer protection and regulation of unfair/deceptive trade practices. It is a bad idea to promise your customers to reward them with loyalty points and then not do it or burn the accumulated loyalty points without warning.
- Tax laws. Rewarding your customer with loyalty points may be considered, in some jurisdictions, a taxable event, meaning either your customer or your business may become liable to pay income tax.
- Privacy laws. Loyalty programs are frequently paired with data collection. If this your case, you should be sure that you are treating the collected personal data in full compliance with laws. You should be double careful if you are subject to some of the stricter legal regimes, such as GDPR, CCPA or LGPD.
There are some additional areas of law that can apply to your loyalty program. For example, some states in the USA can try to apply regulations for “unclaimed property” to the issued loyalty points and force you to turn over the loyalty points to the state if they are unmoved for a certain period. Such cases are the reason why it is a good idea to work with your lawyer on most things you do, including the launch of loyalty programs. Law may be weird.
On the other hand, if you are doing business in the jurisdiction where loyalty programs are common, it is likely that you are already aware of the rules that apply to you. Using Minter or Pinpon as a technical solution for your loyalty program should not by itself trigger the need to comply with additional regulation.
Now we need to get back to the regulatory fears we have discussed in section three and answer whether they apply to Minter and Pinpon. First we will check whether working with loyalty points on blockchain can get you in trouble with securities regulation, then we will take a look at the money transfer regulations.
6. Securities Regulations
It should be rather obvious that security regulations, the reason why ICOs have triggered the regulatory response, should not apply to loyalty points issued on Minter. Nevertheless, it is better to be safe than sorry, so we will briefly describe what activities could trigger securities regulations in the EU and the USA, and why operations with coins in Minter and Pinpon are safe from these regulations.
6.1. USA: Securities Act and Howey Test
We will start with the scariest thing of all: the SEC, the Horror of TON.
ICOs prosecuted in the USA were found in violation of the Securities Act, a law prescribing the rules for dealing with securities. You have probably heard about the Howey test used by the Securities and Exchange Commission (SEC) to determine whether an instrument is a security or not.
The basic scenario of how crypto projects got in trouble with SEC was the following:
- a project offers some tokens to the general public;
- SEC gets information about it and charges the project founders with the offer of unregistered securities;
- SEC proves that the tokens offered met the criteria of the Howey test and thus were, indeed, securities;
- founders agree to refund the investors and pay a substantial fine to the SEC.
To understand whether this scenario can apply to Minter or Pinpon, it will be easier to understand whether loyalty points of Minter or Pinpon can be considered securities under the Howey test.
The test consists of three questions, the answers to all of which should be “yes” for the instrument to be considered:
- Is the instrument offered for money or other consideration?
When offered by a brand to the customer, not necessarily, although customers are usually rewarded with loyalty points because of something they have done. When offered by Pinpon to a brand, most likely, since we are a commercial enterprise.
2. Is the instrument a part of the collective scheme?
No one really knows what it means, but the courts usually consider this to be the case, and so shall we, just to stay on the safe side.
3. Is the person obtaining the instrument hoping to get money from the instrument due to the effort of others?
When offered by a brand to the customer, no. Loyalty points are used to receive goods and services, not as the means of income. When offered by Pinpon to a brand, no. While we believe that your final intention in implementing a loyalty program is to earn money, the money you earn will become yours because of your own efforts, not the efforts of others.
Since the answer to the third question is “no”, the loyalty points are not securities. And that means there is little reason in worrying about the SEC.
6.2. EU: MiFID II
European companies that got in trouble with their regulators because their tokens were considered securities are not as apparent as their American counterparts. For the sake of the symmetry, however, we can check whether European securities legislation will apply to Minter and Pinpon.
While looking at individual national laws of each EU member state seems like too deep an analysis for the purpose of this article, we can use the legislation of the EU itself to understand the general approach as individual countries follow the EU and adopt their legislation to correspond to the EU Directives.
The applicable Directive in this case will be MiFID II, the second version of Markets in Financial Instruments Directive. Since to get in any trouble with the securities regulation, there needs to be a security of some sorts in the picture, we shall take the route similar to the one we took with the Howey test and go straight to the definition of regulated financial instruments as provided by the Directive.
European approach to regulation is less reliant on abstract concepts than the approach taken by the US and more reliant on formal rules. This means that instead of just answering several questions about the nature of the tokens, we will get on a roller coaster of definitions and links. It will be a rather long ride, so we had to hide it under the spoiler; you can either check the logic with us or trust us with the conclusion.
Ready for some legalese?
MiFID II Detailed Analysis
Let’s start by setting some abbreviations we shall use. There will be some jumping between directives, so it may help to have a separate section to check what we are talking about:
ACP — ESMA’s Addendum Consultation Paper MiFID II/MiFIR of 18 February 2015, ESMA/2015/319
CIR — Commission Implementing Regulation No 1247/2012 of 19 December 2012 laying down implementing technical standards with regard to the format and frequency of trade reports to trade repositories as amended by the Commission Implementing Regulation of 19.10.2016
EMIR — Regulation (EU) No 648/2012 of the European Parliament and of the Council of 4 July 2012 on OTC derivatives, central counterparties and trade repositories
ESMA — The European Securities and Markets Authority
MIFID II — Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014
on markets in financial instruments and amending Directive 2002/92/EC and Directive 2011/61/EU
MIFIR — Regulation (EU) No 600/2014 of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Regulation (EU) No 648/2012
RTS 2 — Commission Delegated Regulation (EU) 2017/583 of 14 July 2016 supplementing Regulation (EU) No 600/2014 of the European Parliament and of the Council on markets in financial instruments with regard to regulatory technical standards on transparency requirements for trading venues and investment firms in respect of bonds, structured finance products, emission allowances and derivatives
Emission Directive — Directive 2003/87/EC of the European Parliament and of the Council of 13 October 2013 establishing a scheme for greenhouse gas emission allowance trading within the Community and amending of Council Directive 96/61 / EC (OJ 2003, L 275)
UCITS — undertakings for collective investment in transferable securities as defined in the UCITS Directive
UCITS Directive — Directive 2009/65/EC of the European Parliament and of the Council of 13 July 2009 on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS)
Time to get to some analysis.
Financial instruments are defined by the Article 4(1)(15) of MIFID II as those instruments specified in Section C of Annex I of MIFID II; and they are:
(1) Transferable securities;
(2) Money-market instruments;
(3) Units in collective investment undertakings;
(4) Options, futures, swaps, forward-rate agreements and any other derivative contracts relating to securities, currencies, interest rates or yields, emission allowances or other derivatives instruments, financial indices or financial measures which may be settled physically or in cash;
(5) Options, futures, swaps, forwards and any other derivative contracts relating to commodities that must be settled in cash or may be settled in cash at the option of one of the parties other than by reason of default or other termination event;
(6) Options, futures, swaps, and any other derivative contracts relating to commodities that can be physically settled provided that they are traded on a regulated market, an MTF, or an OTF, except for wholesale energy products traded on an OTF that must be physically settled;
(7) Options, futures, swaps, forwards and any other derivative contracts relating to commodities that can be physically settled not otherwise mentioned in point 6 of this Section and not being for commercial purposes, which have the characteristics of other derivative financial instruments;
(8) Derivative instruments for the transfer of credit risk;
(9) Financial contracts for differences;
(10) Options, futures, swaps, forward-rate agreements and any other derivative contract relating to climatic variables, freight rates or inflation rates or other official economic statistics that must be settled in cash or may be settled in cash at the option of one of the parties other than by reason of default or other termination event, as well as any other derivative contract relating to assets, rights, obligations, indices and measures not otherwise mentioned in this Section, which have the characteristics of other derivative financial instruments, having regard to whether, inter alia, they are traded on a regulated market, OTF, or an MTF;
(11) Emission allowances consisting of any units recognised for compliance with the requirements of Emission Directive.
Transferable securities are defined in Article 4(1)(44) as those classes of securities which are negotiable on the capital market, with the exception of instruments of payment, such as:
(a) shares in companies and other securities equivalent to shares in companies, partnerships or other entities, and depositary receipts in respect of shares;
(b) bonds or other forms of securitised debt, including depositary receipts in respect of such securities;
(с) any other securities giving the right to acquire or sell any such transferable securities or giving rise to a cash settlement determined by reference to transferable securities, currencies, interest rates or yields, commodities or other indices or measures.
Although no formal test for defining an instrument as a transferable security has been devised by the European regulator, the key characteristics of a transferable security can be derived. Such characteristics would consist of three formal criteria and a substantive one.
The formal criteria would be transferability (meaning that the units shall be able to be assigned to another person), negotiability (meaning that the units can be transferred with ease) and standardisation (meaning that the units are sufficiently standardised for the purposes of the ease of search and purchase). In case of loyalty points on the Minter main network, these criteria seem to be fulfilled: they can be transferred between addresses and it can be done sufficiently easily, and loyalty points of one type are standardised. Points within Pinpon may not be freely transferable between addresses — this would automatically exempt them from being considered transferable securities.
The fourth criterion is a substantive one. MIFID II provides a non-exhaustive list of instruments that are typically considered securities; it is likely that this list shall be used as a reference in determining whether a new product can be considered a transferable security. Therefore, to be considered securities, loyalty points must be at least comparable to the examples provided in MIFID II.
The examples provided are the shares and their equivalent, bonds or other forms of securitised debt, and the derivative instruments that give the right to acquire such securities or giving rise to the cash settlement.
Loyalty points do not give rise to cash settlements. They are in themselves neither shares nor bonds; their holders are not entitled to the fixed income like the bonds do, nor do the loyalty points grant their holders the equity stake in any corporation or any other rights, typically associated with shares or their equivalent, such as the right to receive a share in the revenue of the respective business.
It is therefore highly unlikely for loyalty points in either Minter or Pinpon to be considered a transferable security under MIFID II.
Money-Market Instruments
Money-market instruments are defined in Article 4(1)(17) as classes of instruments, which are normally dealt in on the money market, such as treasury bills, certificates of deposit and commercial papers and excluding instruments of payment.
Since loyalty points bear no similarities to these instruments and are not intended to be dealt on the money market, it is unlikely that they could be considered a money-market instrument.
Units in UCITS
Units in collective investment undertakings are defined by the UCITS Directive, Article 1 of which defines UCITS as an undertaking with the sole object of collective investment in transferable securities or in other liquid financial assets referred to in Article 50(1) of the same Directive of capital raised from the public and which operate on the principle of risk-spreading; and with units which are, at the request of holders, repurchased or redeemed, directly or indirectly, out of those undertakings’ assets. Action taken by a UCITS to ensure that the stock exchange value of its units does not significantly vary from their net asset value shall be regarded as equivalent to such repurchase or redemption.
Proceeds from sale of loyalty points are not to be invested in transferable securities or other financial instruments as mentioned in the Article 50(1) of the UCITS Directive, such as financial derivative instruments, units in UCITS or money-market instruments. What is more important, the loyalty points themselves are not redeemable, and there is no intention to repurchase them and/or take action to influence their market price.
It is therefore unlikely that Minter, Pinpon or any brand will be considered a UCITS under the UCITS Directive, and loyalty points are most likely not the units in UCITS.
Derivative Instruments
A derivative is a type of financial instrument whose value is based on the change in value of an underlying asset or a basket of assets. Instruments provided for by the Section C(4)-(10) are all types of derivatives, of which the exact mechanics (option, future, swap, etc.) and the underlying assets (securities, currencies, commodities, credit risk, etc.) vary.
Article 4(1) of CIR mandates that the EMIR report specifies a derivative on the basis of the contract type and the asset class; according to Article 4(2) of CIR the derivative shall be specified in Field 1 of Table 2 of the Annex as one of the following contract types:
(a) financial contract for difference;
(b) forward-rate agreement;
(с) forward;
(d) future;
(e) option;
(f) spreadbet;
(g) swap;
(h) swaption;
(i) other.
Those are the most common types of derivative contracts, and as such are defined in the Article 1(8) — (12) of Annex III to RTS 2:
Future means a contract to buy or sell a commodity or financial instrument at a designated future date at a price agreed upon at the initiation of the contract by the buyer and seller. Every futures contract has standard terms that dictate the minimum quantity and quality that can be bought or sold, the smallest amount by which the price may change, delivery procedures, maturity date and other characteristics related to the contract.
Option means a contract that gives the owner the right, but not the obligation, to buy (call) or sell (put) a specific financial instrument or commodity at a predetermined price, strike or exercise price, at or up to a certain future date or exercise date.
Swap means a contract in which two parties agree to exchange cash flows in one financial instrument for those of another financial instrument at a certain future date.
Forward or forward agreement means a private agreement between two parties to buy or sell a commodity or financial instrument at a designated future date at a price agreed upon at the initiation of the contract by the buyer and seller.
Another type of derivative instrument is a financial contract for difference, which is specified in ACP as a derivative product that gives the holder an economic exposure, which can be long or short, to the difference between the price of an underlying asset at the start of the contract and the price when the contract is closed.
Neither holders of loyalty points nor the Minter, Pinpon, any brand or any third party are subject to obligations similar to specified for the typical derivative contracts, and holders of loyalty points are not entitled to demand any commodity or financial instrument to be sold to them; neither are they entitled to demand an exchange of cash flows in any financial instruments or a cash settlement from any third party. The value of loyalty points is not based on or relate to securities, commodities, currencies, interest rates or yields, emission allowances or other derivatives instruments, financial indices or financial measures, or any other assets, rights, obligations, indices and measures and is only determined based on the current market demand for it. Loyalty points are not used to transfer credit risk.
Loyalty points on Minter may resemble options to a certain extent, since their holders are able to unilaterally exchange loyalty points of one type for another. The difference is that loyalty points grant general ability to transform them into any type of loyalty point, while option contracts grant the owner the right to purchase a specific instrument or commodity. Since none of the types of the loyalty points are to be considered financial instruments or commodities themselves, ability to transform them into one another does not make them a financial instrument, either.
Therefore, loyalty points are unlikely to be considered derivative financial instruments as specified in Annex I Section © (4) — (10) of MIFID II.
Emission Allowances
According to the Article 3(a) of the Emissions Directive, allowance means an allowance to emit one tonne of carbon dioxide equivalent during a specified period, which shall be valid only for the purposes of meeting the requirements of this Directive and shall be transferable in accordance with the provisions of this Directive.
Our activities are not directly connected to the emissions of the carbon dioxide, and loyalty points do not grant anyone the rights to emit carbon dioxide or its equivalents. Seriously, stop producing so much carbon dioxide!
We have come to the last item on the list of financial instruments. It seems that loyalty points on Minter and Pinpon do not match any of them.
MiFID II: Bottom Line
OK, so we have shown that loyalty points are unlikely to be transferable securities (they are not ontologically similar to shares, bonds or their derivatives), and even less likely to be any of the other 10 things the EU considers a financial instrument. This means that operations with loyalty points on Minter or Pinpon are not the subject of regulation of financial instruments on the level of the EU.
With this out of the way, you should get a general idea about why there is little need to worry about our products from the securities regulation point of view. Let’s get to the other part that is concerned with regulations of how the money flows work.
7. Money Transfer Regulations
In this part, we will take the same approach as with securities regulations and look again at the USA with the Bank Secrecy Act and EU with Payment Services Directive II.
7.1. USA: BSA
Overview
The Bank Secrecy Act of 1970 (BSA), also known as the Currency and Foreign Transactions Reporting Act, is a US law requiring financial institutions in the United States to assist US government agencies in detecting and preventing money laundering. Specifically, the act requires financial institutions to keep records of cash purchases of negotiable instruments, file reports if the daily aggregate exceeds $10.000 and report suspicious activity that may signify money laundering, tax evasion or other criminal activities.
Bank Secrecy Act and anti-money-laundering laws define money transmission as receipt and/or transmission of currency/funds or their value to another person or location. A “currency” includes “convertible virtual currencies” that have an equivalent value in or serve as a replacement for real currency.
FinCEN Guidance
According to FinCEN Guidance 2019 dated May 9, 2019 on Application of FinCEN’s Regulations to Certain Business Models Involving Convertible Virtual Currencies, whether a person is a money transmitter under FinCEN’s regulations is a matter of facts and circumstances.
Money Transmission
Money transmission could involve either:
(a) the movement of currency of legal tender to or from accounts originally set up to buy or sell commodities (or securities, or futures); or
(b) the issuance and subsequent acceptance and transmission of a digital token that evidenced ownership of a certain amount of a commodity, security or futures contract.
Money transmission may occur when a person (or an agent, or a mechanical or software agency owned or operated by such person) not exempt from MSB status:
a) uses any representation of currency of legal tender (paper money, coins, Federal Reserve Bank notes, United States notes, funds credited to an account) associated with the purchase or sale of commodities, securities or futures contracts to engage in money transmission;
b) issues physical or digital tokens evidencing ownership of commodities, securities or futures contracts that serve as value that substitutes for currency in money transmission transactions; or
c) issues or employs commodities, securities or futures contracts by themselves as value that substitutes for currency in money transmission transactions.
If you are a money transmitter, then you must comply with the obligations that the BSA and FinCEN place on those types of businesses. Those obligations are the same as those with which companies like PayPal and Western Union have had to comply for decades. They are, generally, three-fold: (1) register with FinCEN; (2) have a risk-based know-your-customer (KYC) and anti-money-laundering (AML) program; and (3) file suspicious activity reports (SARs).
Convertible Virtual Currency (CVC)
The term “virtual currency” refers to a medium of exchange that can operate like currency but does not have all the attributes of “real” currency, including legal tender status. CVC is a type of virtual currency that either has an equivalent value as currency, or acts as a substitute for currency, and is therefore a type of “value that substitutes for currency”.
As mentioned above, the label applied to any particular type of CVC (“digital currency”, “cryptocurrency”, “crypto-asset”, “digital asset,” etc.) is not dispositive of its regulatory treatment under the BSA. Similarly, as money transmission involves the acceptance and transmission of value that substitutes for currency by any means, transactions denominated in CVC will be subject to FinCEN regulations regardless of whether the CVC is represented by a physical or digital token, whether the type of ledger used to record the transactions is centralized or distributed, or the type of technology utilized for the transmission of value.
Do we perform money transmission?
Taking into account the above, the main questions are:
1. whether Minter is a financial institution and performs money transmission
Minter distributed ledger system itself does not perform money transmission but rather represents a public protocol under which the users transmit information about their actions within the system to one another. Yes, such information transmission may facilitate value transfer from one user to another in the form of digital token transfer, but it depends greatly on the features of the digital token itself to determine whether it would substitute currency or not. As regulatory practice has shown, public blockchain protocols do not qualify as financial institutions and do not fall under the scope of the BSA.
2. whether Pinpon is a financial institution and performs money transmission
Pinpon is a service that can help design and integrate a custom loyalty program. Pinpon basically helps businesses create a branded loyalty point that is going to be used in their loyalty program and determine the terms and conditions of such a program. Pinpon itself does not act as an intermediary during the transfer of loyalty points because such transfers occur in a peer-to-peer manner directly between users and brands. Thus, Pinpon does not qualify as a financial institution and does not fall under the scope of the BSA.
3. whether loyalty points issued with the help of Pinpon qualify as convertible virtual currency and their transfer qualifies as money transmission
As it has been mentioned before, Pinpon is implementing the compliance by design approach, providing technical limitations to the coins transfer that protects the system from triggering regulatory response. Taking into account the evolving regulatory landscape, however, it is worth anticipating that current uncertainty around legal qualification of loyalty points may be dispelled by the regulators. Nonetheless, Pinpon still strives to deliver a loyalty program management tool that mitigates legal risks by following best practices of the loyalty program design. Pinpon would not allow loyalty points to be redeemed for cash but rather points would be exchanged to goods or services of the brands, and secondly, Pinpon would restrict the secondary market for loyalty points to distance loyalty points from being qualified as a substitute for real currency.
7.2. EU: PSD II
On the European level, money transmission is governed by the PSD II, the second edition of the Payment Services Directive. If a company is considered to render payment services as defined by the directive, it will trigger a bunch of unpleasant obligations, such as registration with financial authorities and compliance with rather strict regulations. While this shall not concern the brands who use Minter or Pinpon loyalty points, if Minter or Pinpon themselves were to be considered providers of payment services, it would most certainly be inconvenient for everyone involved.
Since we are dealing with the European legislation again, a lot of things will be hidden under the spoiler. As with MiFID II, feel free to check our logic or jump straight to conclusions.
Attention: another piece of fascinating legal analysis ahead!
PSD II Detailed Analysis
Time for some abbreviations, to keep things professional and so that reading links would be feasible:
EMD — Directive 2009/110/EC of the European Parliament and of the Council of 16 September 2009 on the taking up, pursuit and prudential supervision of the business of electronic money institutions amending Directives 2005/60/EC and 2006/48/EC and repealing Directive 2000/46/EC
PSD — Directive 2007/64/EC of the European Parliament and of the Council of 13 November 2007 on payment services in the internal market amending Directives 97/7/EC, 2002/65/EC, 2005/60/EC and 2006/48/EC and repealing Directive 97/5/EC
PSD II — Directive (EU) 2015/2366 of the European Parliament and of the Council of 25 November 2015 on payment services in the internal market, amending Directives 2002/65/EC, 2009/110/EC and 2013/36/EU and Regulation (EU) No 1093/2010, and repealing Directive 2007/64/EC
Ok, let’s dive into the logic of the Directive. There are two questions we need to address: are operations with loyalty points payment services (they’re not) and what will we do if they are (don’t worry).
Are operations with loyalty points payment services?
As stated in Article 4(3) of the PSD II, the payment service means any business activity set out in Annex I of the Directive. Those are:
1. Services enabling cash to be placed on a payment account as well as all the operations required for operating a payment account.
2. Services enabling cash withdrawals from a payment account as well as all the operations required for operating a payment account.
3. Execution of payment transactions, including transfers of funds on a payment account with the user’s payment service provider or with another payment service provider:
(a) execution of direct debits, including one-off direct debits;
(b) execution of payment transactions through a payment card or a similar device;
(с) execution of credit transfers, including standing orders.
4. Execution of payment transactions where the funds are covered by a credit line for a payment service user: (a) execution of direct debits, including one-off direct debits;
(b) execution of payment transactions through a payment card or a similar device;
(с) execution of credit transfers, including standing orders.
5. Issuing of payment instruments and/or acquiring of payment transactions.
6. Money remittance.
7. Payment initiation services.
8. Account information services.
It is necessary to assess whether our activities can be considered as each of the following. It is possible to group together the services mentioned in the Annex I (1) and Annex I (2) as operations with the payment accounts, as well as to group services mentioned in the Annex I (3) and Annex I (4) as operations regarding payment transactions.
Operations with payment accounts
Payment account is defined in Article 4(12) of PSD II as an account held in the name of one or more payment service users which is used for the execution of payment transactions. Payment transaction in accordance to Article 4(5) means an act, initiated by the payer or on his behalf or by the payee, of placing, transferring or withdrawing funds, irrespective of any underlying obligations between the payer and the payee. Funds are defined in Article 4(25) and mean banknotes and coins, scriptural money or electronic money as defined in Article 2(2) of EMD.
Loyalty points are clearly not banknotes, coins or scriptural money (that just means money in the bank account); we need to check
Another question that must be answered is whether the special regime for electronic money as covered by the EMD can be applied to loyalty points.
According to the Article 2(2) of the EMD, ‘electronic money’ means electronically, including magnetically, stored monetary value as represented by a claim on the issuer which is issued on receipt of funds for the purpose of making payment transactions as defined in point 5 of Article 4 of Directive 2007/64/EC, and which is accepted by a natural or legal person other than the electronic money issuer.
Loyalty points do not seem to satisfy this definition; they are not represented by a claim on anyone, since they are non-redeemable, and neither Minter nor Pinpon nor any brand is obliged to make any payments in respect to the holders of loyalty points.
All of this means that loyalty points are not funds, resulting in transactions made with them not being payment transactions under this Directive and making both Annex I (1–2) and Annex I (3–4) not applicable.
Issuing of payment instruments and/or acquiring of payment transactions
According to the definitions in Article 4(13–14), payment instrument means a personalised device(s) and/or set of procedures agreed between the payment service user and the payment service provider and used in order to initiate a payment order, which is an instruction by a payer or payee to its payment service provider requesting the execution of a payment transaction.
Since operations with loyalty points do not constitute payment transactions, neither Minter nor Pinpon nor any brand can be considered issuing payment instruments or acquiring payment transactions.
Money remittance
Money remittance is specified in Article 4(22) as a payment service where funds are received from a payer, without any payment accounts being created in the name of the payer or the payee, for the sole purpose of transferring a corresponding amount to a payee or to another payment service provider acting on behalf of the payee, and/or where such funds are received on behalf of and made available to the payee.
These services are not connected to the possible uses of loyalty points.
Payment initiation services
According to Article 4(15), payment initiation service means a service to initiate a payment order at the request of the payment service user with respect to a payment account held at another payment service provider.
We have already established that payment orders can not be done with loyalty points, so this does not apply.
Account information services
Account information service is specified in Article 4(16) as an online service to provide consolidated information on one or more payment accounts held by the payment service user with either another payment service provider or with more than one payment service provider.
We do not provide such services.
We have exhausted the list of things that are payment services, and we are fairly certain that operations with loyalty points are not them.
But what if they are?
We believe that operations with loyalty points do not constitute payment services, and loyalty points can not be considered payment instruments as defined by the PSD II. But even if they were, the regulations would still be inapplicable due to the exemptions provided by the Article 3(k) of the Directive.
According to this exemption, PSD II does not apply to services based on specific payment instruments that can be used only in a limited way and fulfil one of the following conditions:
(i) instruments allowing the holder to acquire goods or services only in the premises of the issuer or within a limited network of service providers under direct commercial agreement with a professional issuer;
(ii) instruments which can be used only to acquire a very limited range of goods or services.
The brands we are working with are that limited network of service providers, and acquiring goods and services is the reason why customers get loyalty points in the first place! The exemption in Article 3(k) was introduced with exactly this purpose: to not burden the issuers of loyalty programs with excessive regulations.
PSD II: Bottom Line
So, as you can see, activities with loyalty points by themselves should not be considered payment services. This is due both to the fact that loyalty points are unlikely to be considered funds under the definition provided by the Directive and because, even if they are, operations with them would fall under the exemptions provided by the Directive.
This will conclude the legal analysis part of this article. We hope you feel a bit more reassured now!
8. Loyalty Points: Conclusion
All of this doesn’t mean that you can do whatever you want with our loyalty solutions and stand above the law. There are plenty of rules to break and plenty of consequences to face. As we have mentioned, if you try to defraud your customers, you will most certainly get in trouble with the consumer protection law; if you negate your tax responsibilities, someone will surely notice; and if you break our Terms and Conditions, we will retaliate. And even though we have demonstrated that securities and money flow regulations are unlikely to be triggered in the normal course of business with us, we are sure that there are talented crooks in this world who could turn any instrument into a security fraud or a shady money-laundering scheme.
But our purpose was not to boast about a system that will let you run free from any government intervention. Our goal was to demonstrate that while the legal landscape that we are working with can be hard to navigate, it is manageable.
Don’t be reckless, but don’t be afraid, either! Grab your trusted legal advisor, contact us and embark on a journey to explore customer loyalty. Should be fun.
