FedNow’s legal terms contain a game changer for digital wallets and payment apps


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Jess Cheng


Jess Cheng is a partner at Wilson Sonsini Goodrich & Rosati PC and previously served as senior counsel at the Board of Governors of the Federal Reserve, with responsibilities relating to the oversight and regulation of the FedNow Service, as well as counsel and officer at the Federal Reserve Bank of New York.

A few lines buried in the legal terms for the FedNow service, which is now live, create an important opportunity for digital wallet and payment app providers. While the new FedNow legal regime creates significant business opportunities for all players in this space, emerging nonbank payment providers may have the most to gain from this change.

Early-stage startup founders and investors in particular should take note. These provisions allow nonbank providers access to FedNow under a remarkably open approach, with only a few requirements imposed on their relationships with customers and a back-end bank. The effect is to allow these nonbank providers to increase their reach beyond their own user base (as they are limited today) and potentially also enable payment flows across other apps and wallets and payment networks.

Rather than orient their business around customer acquisition and user base growth, early-stage startups would be able to play to their strengths and center on building innovative software solutions — ones that identify new opportunities and deliver a better and safer customer experience for instant payments.

Payments on the cusp of change

Rarely do we see wholly new digital wallets or payment apps launched by nonbank startups today. Instead, the biggest payment app providers tend to grow bigger: Their app becomes more useful as the number of customers using it grows. That is because the payments these nonbank providers are able to process within their own system are limited to only transfers between their customers.

As a result, the larger the user base of one particular wallet or app, the more likely it is that a payor can use it to make a payment to a payee, increasing that system’s functionality and value. Because of these network effects, the barriers to entry for new nonbank payment systems are high.

But what if there were some way for a startup to launch a wallet or app that allows its users to also send money directly to a bank account or to a wallet with a totally different nonbank provider — cheaply and within seconds?

This possibility would mean that the usefulness of that payment solution would no longer depend on the size of the nonbank provider’s own customer base. Instead, even nascent payment solutions could reach nonusers who are customers of banks and possibly of other nonbank providers.

A new payments app could launch with readily available reach to a vast network of payors and payees. Both startup payments providers and today’s dominant providers could broaden their reach.

This possibility is real with the FedNow Service and, in particular, its legal terms for nonbank providers.

The FedNow legal terms

The FedNow Service is a new instant payment infrastructure developed by the Federal Reserve. The service went live on July 20, 2023, and enables consumers and businesses to instantly send and receive money through their banks, around the clock and every day of the year, with funds to be available to the recipient immediately.

Importantly, the Federal Reserve designed the FedNow Service to enable fintech companies and other nonbank providers to integrate instant payments into their more innovative and customer-centric services. This goal is evident in how the Federal Reserve’s approach to these nonbank providers differs from that of The Clearing House (TCH), operator of RTP, the private-sector instant payment service.

Specifically, under RTP’s operating rules, a nonbank provider can access RTP through a bank only if the nonbank provider submits an application that has been accepted by TCH, enters into an agreement with TCH, and submits an annual certification with a certain audit report, among other requirements.

In contrast, the Federal Reserve’s legal framework for the FedNow Service takes a remarkably more open approach. The nonbank provider must have certain agency relationships in place with its customers, and it must maintain an account on behalf of its customers with a bank that participates in the FedNow Service — and that is it. These types of legal structures are not uncommon — we see them, for example, in arrangements where a fintech company holds customer funds as the customers’ agent at a bank.

Nonbank digital wallet and payment app providers in particular can take advantage of this aspect of the FedNow Service terms to expand their reach in unprecedented ways. With these legal relationships in place, for example, a nonbank provider could leverage the FedNow Service as a bridge for its wallet or payment app to directly send payments to or receive payments from any deposit account with a bank that participates in the FedNow Service, within seconds. Of course, the same constraints that apply to the FedNow Service generally would continue to apply (e.g., it is generally limited to U.S. customers).

The potential reach for nonbank payments providers who leverage this provision in the FedNow legal terms could be significant. Indeed, a core goal of FedNow is to provide ubiquitous access to an instant payments system via depository institutions. The U.S. Department of the Treasury’s Bureau of the Fiscal Service and various banks are among the list of early adopters of FedNow, signaling that federal government payments will be flowing over its rails. As history has shown with the growth of ACH payments, participation by U.S. government agencies in a payment system drastically amplifies that system’s ability to scale and reach ubiquity. As the Fed has explained:

The Reserve Banks became an ACH operator in large part because of the Reserve Banks’ role as fiscal agent of the U.S. Treasury and because of the synergies between the ACH and the Federal Reserve’s then-existing check service. The U.S. Treasury, earlier than most businesses, embraced the use of the ACH as a potentially more efficient way to make many of the government’s payments, particularly payroll for military and civilian workers and benefit payments such as Social Security. (Until the mid-1980s, most ACH volume was originated by the federal government.) The combination of commercial and government ACH payments created economies of scale earlier than might otherwise have been the case, allowing the ACH to become a broadly used national service.

This is a significant moment of change in the U.S. payments industry, and rare opportunities exist for early-stage startups in particular and their investors. By taking advantage of FedNow and its specifically innovation-friendly legal terms, lean startups can better devote their resources to strategically identify new opportunities for a better and safer instant payment customer experience — building creative technology solutions to deliver it. The startups that seize this opportunity to break out of the current paradigm will be the most successful.

The opinions expressed are those of the author and do not necessarily reflect the views of their employer or its clients, or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

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