Untangling Issuing, Chargebacks, and Principal License of Card Schemes. A different view of the Union54.
On the 17th of July, customers of some African fintechs received messages informing them of discontinued access to their virtual dollar card service.
The service disruption also prevented them from creating new virtual dollar cards or funding existing ones.
At the centre of this news is an innovative African fintech — Union54.
They are about 2 years old, have raised over 15 million dollars, and offer an API platform enabling software companies in Africa to issue and manage their debit cards. All these, without the need for a bank or third-party processor.
This is the company powering the virtual dollar card service for a number of Fintechs, including Africa’s most valued start-up.
This phrase ‘without the need for a bank or third-party processor’ would interest Fintech specialists who are aware of the regulations and card scheme policies on card issuance.
Days after the news broke, questions like — how is an African fintech able to pull this off? Why haven’t Traditional banks or older Fintechs jumped on this? and what went wrong? were all over the place. I had similar questions so I went digging.
Side note: This is to thank everyone who I’ve harassed over the past 2 weeks with those after-dinner long chats on this subject. Your time and patience are most appreciated.
A peek at the Card Network Member Hierarchy.
So we start off by understanding how Card Schemes license members to carry out different activities. I’ve drawn a little picture to help.
Principals are the most important member class. Principal licenses are issued to financial institutions or legal entities authorized to engage in financial transactions by the regulations of the market they operate in. They have a direct relationship with the Scheme and as such have more responsibilities. They own an account where they receive settlements directly, they also own an ICA and of course a BIN or more. By implication, Principals can also sponsor other BINs.
Card Networks usually issue the Principal licenses to Commercial banks but sometimes make ‘strategic’ exceptions. This was what happened in the case of Union54. It is also worthy to note that Network International also has the Principal license from Mastercard. This license gives access to the very important Mastercard connect -( MPGS, MIGS, and MIP).
The concept of area of use: The Principal license isn’t without limitation as the concept of the area of use limits a Principal’s activity to a specific country/tries. To move outside your area of use, for e.g. If Union54’s AoU is for Zambia and they need to work with Fintechs outside Zambia, they’ll have to apply for an extension of area of use. Some publications noted compliance concerns as the possible reason for the shutdown, could this be one? We don’t know yet.
The ability to sponsor Affiliates: We almost forgot the Affiliates, they are the next in the hierarchy, but with less power compared to the Principals. Affiliates also need to be licensed FIs per their market regulations but need to be sponsored by a Principal to operate in the network. Their settlements are attached to their Principals. However, they own their BIN. So if the aforementioned Fintechs had been Affiliates, they will not need to shut down their card services, they’ll simply move their settlement to another Principal with an AoU in the same market.
This means that the Fintechs who were issuing with Union54 didn’t own the BINs or the infrastructure or could receive settlement outside that arrangement. So, if Union54 went down, so did they. 100%
It’s beginning to come together right? Yup! But Fintechs, in Nigeria, are not licensed to issue cards so they cannot be affiliates. If you’d like to read more about it, here you go. Check page 4, section 3.0.
Summarizing what we have learned so far — Union54 is a licensed Principal on the Mastercard network. This allows them access to Mastercard modules, a range of BINs, a direct settlement account, an ICA, and the ability to sponsor other Affiliates to the extent their AoU allows them to. All of these are supported by a robust Card issuing API that reduced the time to take payment card products to market making this Fintech an Investor’s dream. But they didn’t limit themselves to a market they could access directly or through affiliates, they focused on reaching more customers by enabling Fintechs to issue cards..‘without the need for a bank or third-party processor’. We’ve solved that puzzle right? so what went wrong?
The thing about Chargebacks.
Chargebacks were cited by a few articles as the reason Mastercard disabled the Union54 BIN. It was alleged that this excerpt was sent by one of the founders: ‘ “Ever since we launched, there’s been a consistent increase in fraud cases emanating from our Bank Issuing Number (BIN)”
True or not, let’s focus on unpacking Chargebacks. Trust me, you’ll want to read this.
There are 2 types of chargebacks: The popular consumer chargeback initiated by the customer and the authorization chargeback initiated by the Issuer.
Let’s appreciate how merchants make risk management decisions in order to understand chargebacks. For some amounts, Merchants have the ability to 1st approve transactions, and later send them for authorization to the issuer. If you’ve bought a cheap Udemy course, you’ll notice that you have access to the course before your bank debits you. Merchants decide on these risk parameters based on stuff like if it’s a card present transaction, If a pin is sent, If it’s a recurring transaction, if a 2FA is involved etc.
If the Merchant decides to approve a transaction, later sends it to the issuer to debit and no funds are available, the Issuer sends an authorization chargeback to the Merchant through the network.
If the Merchants allows the Issuer to authorize the transaction, but the customer complains ( for a variety of reasons), the issuer sends a consumer chargeback on behalf of the customer.
The process of raising chargebacks.
The whole process is timed, and if the Merchant doesn’t respond within a specific duration, the liability falls on them and they have to pay. For Mastercard, this duration is 45 days. This seems like a lot of time but not for really large merchants like Amazon, Facebook, and co. The problem starts from number 3. Sometimes the Acquirer’s level of automation doesn’t allow them to respond quickly and kick off investigations. And of course, the ultimate is at number 5 where the merchant doesn’t have a team/person focused on chargebacks and every claim is automatically accepted. Fraudulent consumers know this, and use it against the system.
It takes a whole village to combat fraudulent chargebacks; Merchants, processors, Issuers, and every stakeholder in between. Chargebacks do not only happen for USD virtual cards, the Nigerian Fintech ecosystem has been struggling with related losses especially since the CBN reduced dispute timelines to 24 hours. A Fintech CEO of a successful MMO told me how customers cash out from their wallets one minute and head straight to their Issuer to ‘complain’ about a fraudulent withdrawal which they did of course.
Alternatives, Suggestions, and next steps
Ahh, this article is getting long, but I hope it’s helping with some insight. Before I sign out it is worthwhile considering what the alternatives are as there is a clear market fit for USD virtual cards.
- Traditional Banks and Older processers enter the ring: If Mastercard is open to licensing Fintechs as Principals, I believe more Fintechs can make the cut in Africa. The only issue is the FX for settlement which is a growing concern in Nigeria. Is this the same concern that prevented Traditional banks from participating?
- Improve robust reconciliation processes to detect chargeback: Regardless of the time allotted to deal with chargebacks, automation always changes the game. It empowers Merchants, Acquirers, and processors to quickly respond to claims and detect fraudulent ones. As RegTech platforms mature, it will be nice to see a few of them niche down on this.
- Improve and centralize Regional fraud monitoring: On the Issuing end, a lot can be done to detect and report cards and customer IDs that have been engaged in illegal chargebacks. Deji Olowe wrote about how Fintechs can collaborate with each other. Imagine the possibilities when Issuers ( Fintechs and Banks) in our region co-create this database by pulling info. They can share this with the Network fraud platforms, so acquirers can make more informed risk processing decisions for transactions.
I trust Union54 will learn the lessons they need to and be the better for this experience. Fintechs take a couple of hits as they navigate growth, so it’s nothing unusual. On another note, I am excited at the audacious goal they mentioned at their last raise: to build a domestic competitor to Mastercard and Visa. Tick tock.
