Back in July 2024, the Financial Conduct Authority (FCA) and Payment Systems Regulator (PSR) issued a "Call for Input on Big Tech and Digital Wallets". Recently, they published their feedback statement setting out their findings and providing indications as to the direction of regulatory travel in this area.

Digital wallets are increasingly popular in the UK. The FCA and PSR found that, in 2023, the proportion of card transactions using a digital wallet had increased to 29% and that approximately 20% of customers used a digital wallet for more than 50% of their card transactions. The regulators identify digital wallets as a growth area, whilst also noting that there are challenges and risks.

Digital wallets are apps, software or online services that allow consumers to make payments using mobile phones or other electronic devices. They securely store payment information and can use features like biometric identity verification. This allows users to make payments without needing a physical card. Currently, most digital wallets are linked to debit and credit cards, but the potential of the technology is not confined to such links.

Apple and Google are the largest providers of digital wallets and the feedback statement forms part of the FCA and PSR's response to the CMA's invitation to comment on its investigations into Apple and Google's mobile ecosystems. The CMA has confirmed that digital wallets are within scope of its possible interventions in this investigation.

At present, the FCA and PSR are not proposing any direct work themselves, but they have identified a number of issues on which they are looking to work with the CMA and HM Treasury. In particular, the review of the Payment Services Regulations and the Electronic Money Regulations is identified as a potential route to addressing issues. The net effect is that digital wallets remain firmly on the future regulatory agenda.

What are the issues?

• Competition between digital wallets

This is primarily a technological issue, with concerns raised regarding access to near field communication technology and pre-installation of wallets on devices.

• Competition between payment systems in wallets

Pass-through wallets typically only offer card payments. The FCA and PSR identify possible growth opportunities for digital wallets in open banking account-to-account payments, stablecoins and central bank digital currencies.

• Operational resilience and consumer protection

If consumers rely more on digital wallets, they become vulnerable to operational failures in the wallets, which could leave them unable to make payments. Retention of physical cards and cash would mitigate against this.

• Legal powers and the regulatory perimeter

Some of the feedback suggested bringing digital wallets within the regulatory perimeter. Such a step could have significant ramifications for existing providers. The PSR notes that some providers may already be classed as "participants" in a payment system under the Financial Services (Banking Reform) Act 2013 depending on the nature of the services they supply.

What are the opportunities and benefits?

Digital wallets offer opportunities for wider payment options and services. The feedback statement notes that some wallets have started to offer buy now, pay later options (which is itself likely to become regulated later this year). However, there are many options for innovation and development, a number of which are outlined in the feedback statement. For example, integration of open banking options such as account-to-account transfers could enable the movement of funds directly between bank accounts through digital wallets. Leveraging open banking APIs could also provide services such as spending insights and real-time lending decisions.

Further technological integration is also anticipated, with a potential ability to optimise reward and loyalty programmes, and to provide smart contract functionality.

Digital wallets also offer scope to incorporate digital identity services. This could streamline age verification and licensing checks, and assist with secure access to buildings and services.

Intersecting with other financial services regulatory developments, the FCA forecasts that digital wallets could become central to the management of various cryptoassets including central bank digital currencies, stablecoins and non-fungible tokens. Digital wallet providers offering crypto-related services will need to watch regulatory developments closely to ensure they remain on top of registration and authorisation requirements. Certain crypto-related services are already within scope of the anti-money laundering regulations and the FCA's crypto roadmap highlights the regulator's plans to bring more cryptoassets and activities within scope of regulation.

Digital wallets can offer greater security and efficiency for customers and potentially improve financial inclusion for some customers. The feedback statement notes that the use of biometric identification can provide a more secure method of payment, allowing for higher authorisation limits and greater protection against unauthorised use of such payment method.

Regulatory gaps

One regulatory gap identified in the feedback statement is the liability of card issuers for ensuring that strong customer authentication requirements are met and the liability of card issuers for unauthorised payment transactions. Stakeholder feedback raised concerns that, with digital wallets, this raises a disconnect as the wallet provider enables the payment but does not hold any liability.

It was also noted that card issuers have obligations under the FCA's Consumer Duty, including to customers who are less able to engage digitally. The prevalence and use of digital wallets could become exclusionary, where digital wallets become a precondition of using particular payment services.

What should digital wallet providers and firms be considering?

The feedback statement notes that the inclusion of pass-through wallet providers in the FCA regulatory perimeter is an issue that the FCA will be examining as part of its review of the Payment Services Regulations and Electronic Money Regulations. It will engage with HM Treasury to consider this and other potential options. Digital wallet providers and payment service providers should remain alert to the outcomes of this review.

Digital wallet providers should also ensure that they remain aware of developments in the regulation of cryptoassets and activities where they intend to develop wallets to provide such functionality. Where wallets already provide crypto-functionality, providers should ensure that they have reviewed their services to ensure that they are on top of their regulatory obligations in a fast-developing area.

In light of the PSR's comments regarding participation in a payment system, digital wallet providers should also review their services to ensure they have identified whether this applies to them.