Understanding closed-loop, open-loop, and regulatory complexity in prepaid card systems

October 16, 2023

If you’ve delved into discussions within the payment industry or explored the nuances of prepaid card systems, you’ve likely encountered terms such as “closed loop,” “open loop,” “restricted open loop,” or “semi-closed loop.” These terms, while fundamental in categorising payment instruments, often lead to confusion, especially when it comes to their legal implications.

What do these terms mean?

Closed loop

Cards that can only be redeemed at the store that issued them fall under this category. They are limited to one merchant or a small, close-knit community.

Open loop

On the other hand, “open loop” cards are flexible payment methods that are accepted at a wide range of establishments. Prepaid credit cards from well-known companies like Visa and Mastercard are among them.

Systems that lie in between closed and open loops are known as restricted open loops or semi-closed loops. They permit redemption inside a certain network or at a more restricted range of retailers. Shopping centre cards, for example, might only be accepted at the retailers located in that particular shopping centre.

What they do not imply

Despite their apparent clarity in describing card acceptance, these terms should not be used to determine the legality or regulatory compliance of such cards. The confusion arises when these terms are applied within the regulatory framework, particularly under the German Payment Services Supervision Act (Zahlungsdiensteaufsichtsgesetz – ZAG).

The heart of the matter lies in whether these prepaid cards qualify as e-money, as defined by the ZAG. E-money refers to electronically stored monetary value issued against payment to conduct transactions and accepted by parties other than the issuer. Crucially, the aspect of third-party acceptance is pivotal in determining if a card constitutes e-money.

Handling legal complications

Prepaid cards that meet the requirements for e-money cannot be issued without authorization unless they come under one of the legal exceptions. In this context, the exceptions to the limited network and limited range are important. These exclusions require that the prepaid cards’ use be restricted to particular locations or a small network of service providers.

BaFin, the German financial supervisory body, has provided a thorough list of requirements in its Information Sheet – Notes on the Payment Services Supervision Act for these exclusions.

In conclusion – seeing past the labels

Although the classification of payment instruments from an acceptance standpoint is facilitated by the phrases closed loop, open loop, restricted open loop, and semi-closed loop, the regulatory environment is frequently confused by these concepts. In this field, legal terminology is quite important.

Comprehending the subtle differences is essential for adhering to regulatory standards and maintaining compliance, particularly with regard to e-money and its exclusions.

In summary, although these concepts are useful for comprehending the acceptability of payment systems, their use in regulatory discourse necessitates a more sophisticated and legally accurate approach.