ETA Expert Insights: To Be or Not to Be (a PayFac)

By ETA Payment Facilitator Committee
George Malesky, Chesapeake Bank • CJ Schneller, MerchantE • Manpreet Singh, Payscout

The payment facilitator (PayFac) model is changing the way merchants process payments, and many service providers are still navigating the changing landscape. To help support this process, ETA has put together the following guide, including a self-service quiz (to be launched next week), for prospective PayFacs.

By enabling service providers to act as the payment facilitator (also known as the “merchant of record (MoR), PFAC, or PayFac”) and onboard numerous submerchants under the PayFac structure, the payment facilitator can bring on many submerchants efficiently and without the typical friction involved in the underwriting and onboarding processes.

The appeal of this model is enough to compel independent sales organizations (ISOs), technology providers, and others to consider either partnering with an existing PayFac or building their own model. Unfortunately, the reality is that not all entities are equipped to support the kind of infrastructure required.

“There is no doubt that taking on the role of payment facilitator can be a phenomenal opportunity for software companies, but choosing the right structure is critical to ultimate success,” says Manpreet Singh, President and Co-Founder of Payscout. “Given the financial commitment, technological requirements, and compliance responsibilities, businesses should ensure that they are fully capable of managing the obligations necessary to become a PayFac.”

Before you can answer the question of whether to become a PayFac, you must first understand the requirements.

What defines a PayFac?

• PayFacs are sponsored by an acquiring bank that has a direct relationship with the card brands.
• To be approved by the acquirer and card brands, PayFacs undergo strenuous review to ensure they have sound compliance and control policies and procedures to justify the relationship.
• PayFacs are authorized to board submerchants without the submerchant having a direct relationship with the acquirer.
• PayFacs typically provide some, or all, of the technology infrastructure needed to enable their submerchants to accept payments.
• PayFacs most often handle the underwriting and risk management responsibilities related to their submerchants’ accounts.
• PayFacs initiate the funding and settlement to their submerchants either under a fixed-base operator (FBO) structure with their sponsor bank or by being in the flow of funds. Being in the flow of funds is subject to money transmission regulations.
  • PayFacs provide instructions to the acquiring bank about where to apply settlement deposits.
• PayFacs ensure their submerchants comply with bank-card rules, applicable laws, Program Standard, and industry best practices.

While the PayFac model provides clear benefits, it can also introduce impediments if not implemented and managed properly. “There are many reasons to want to become a PayFac,” says George Malesky, Vice President of Sales at Chesapeake Bank. “With increased income from merchant processing revenue and higher company valuations, the driving factors are obvious, if your focus is solely financial. However, just because an ISV — or any entity new to payments — wants to become a PayFac, that does not mean they should become one. There are many responsibilities that are part and parcel of payment facilitation. You need to know exactly what you are getting into and be cognizant of the risks.” Each business should take an honest look at its current situation and perform diligence before deciding on the proper path to follow.

When deciding to be or not to be a PayFac, here are some of the questions you should be asking:

• Are we sponsored by an acquiring bank that has a direct relationship with the card brands?
• Are we built to handle the underwriting and risk management on a portfolio of submerchant accounts?
• Are we willing and able to manage the risk associated with the payments?
• Do we have the technology and infrastructure required to enable submerchants to accept payments?
• Do we have policies, procedures, and systems to ensure bank-card compliance across a portfolio of submerchants?
• Can we contract with third parties to assist with the above?
• Do we have the personnel to oversee these responsibilities?
• Is there a Director of Compliance who understands the obligations of anti-money laundering (AML) concerns and annual audits?
• Do we have a system to train all employees on AML and other aspects of the business?

These are just a few of the questions you should ask yourself before deciding on the best payment model for your business. Maybe you are ready to become a full-fledged PayFac, maybe the answer is a managed PayFac, or maybe the best solution would be to act as an ISO.

“One of the largest challenges a new PayFac will face is meeting the rigorous demands of its sponsorship bank,” says CJ Schneller, Vice President of Enterprise Risk at MerchantE. “The regulatory requirements and risk management expectations levied on banks are passed through to the sponsored entity, and many companies looking to become PayFacs may not be ready to meet these strict requirements.”

Prospective PayFacs should fully understand the expectations of their sponsoring bank when determining if this is the right path for their organization. But remember, there is no one-size-fits-all approach when it comes to PayFacs. Some models involve the PayFac directly funding clients, underwriting clients, performing compliance (AML/BSA/OFAC) checks, and monitoring transaction fraud risk and chargebacks — which results in more requirements passed through to the PayFac. Other models may involve a partner, payment processor, or even the sponsor bank performing some, or all, of these activities, thus reducing the requirements and oversight burden placed on the PayFac.

If you decide that building out your own PayFac solution is not a viable solution, there are several questions to ask before aligning yourself with an existing payment solution provider. Before making any decision, be sure to fully understand the provider’s commitment to the following:

1. Stability — Do they have experience successfully implementing and managing the payment model you are looking to achieve, and do they have a thorough understanding of your business (and the verticals you support)?
2. Redundancy — Given that sponsor banks can change their philosophy or adjust their risk appetite at any time, do they have strong relationships with multiple acquirers to allow for payment processing continuity?
3. Compliance — Do they consistently adhere to all requirements of state laws, federal law, and card brand rules?

ETA PayFac Quiz
To help you better understand the best fit for your business, ETA has put together a self-service quiz to aid in the process. The ETA PayFac Quiz will help you discover which payment monetization model is right for you. The quiz examines the size, revenue, and risk aversion of what you’re selling. You will leave with advice on the best payment monetization model for your business.