We recently published an article discussing the differences between closed-loop and open-loop payment systems. While the two represent distinct realms, they can complement each other well in a single system. Closed-loop systems have been the standard in the past, and open-loop payments have emerged as a supplementary method to pay for transit rides by adding to existing ticketing platforms and closed-loop systems. This solution allows passengers to travel on public transport networks by tapping their preferred bank card, such as a credit or debit card, or using their smartphone or smartwatch. In this article, we’ll examine some of the myths and realities surrounding open-loop payments in transit, with the help of our Chief Technology Officer (CTO), Pavel Iliev.
Addressing some of the misconceptions surrounding open-loop systems
One of the biggest misconceptions regarding the use of open-loop systems has to do with the Level 3 certification. Level 3 (L3) testing is used to validate the integration of EMV®-compliant payment acceptance terminals with merchant or bank systems. To facilitate widespread acceptance of EMV cards, merchants must undergo rigorous testing and certification processes. The EMV certification guarantees secure data flow after users tap their cards and the bank processes the payment.
The main participants in a transaction:
- The riders’ card
- Card reader
- The payment app that works with the reader and communicates with the acquirer
- Bank (Acquirer)
A standard requirement is that the reader used in the system by the validators should have EMV Level 1 and Level 2 certifications. After this, the whole system dealing with payment processing should be Level 3 certified. This is where the majority of the projects struggle because to get a Level 3 certification, they need to have a bank that supports the transit transactions. This is called the acquirer or acquiring bank that receives the money/payments from the rider. These banks should comply with VISA and MasterCard standards and requirements for public transportation, such as ISO 8583.
Why choosing the right acquirer matters
The number of banks that are certified and prepared to handle these requirements is very few. In Europe, fewer than a dozen banks are certified to handle this kind of payment processing. Things are even more complex in the United States, with only several banks such as Chase, World Bank, and Elavon meeting the criteria. If a municipality or an agency selects a bank that has not been certified for public transit, the length of the project could increase to around 2 years, because the vendor’s system or payment gateway that processes the transactions will need to integrate with the bank. This requires development effort from both the vendor and the acquiring bank. The system is then certified by the payment network schemes, such as VISA or MasterCard.
Level 3 certification can be very slow and expensive
A big problem for transit agencies is choosing an acquirer that is not already certified with the readers that are part of the system. This is because payments are processed through the reader, then a payment app, and then the acquirer. If something changes in this chain, a new complete recertification has to be carried out. The certification is usually about $5000 per card schema, but the full integration can be costly and take years. Such obstacles can bring open-loop projects to a halt, ultimately resulting in their failure. The complete integration that refers to the bank implementing the transit specification and the Visa/Master certification can easily take more than 1 year. Then the final L3 certification can add six more months.
Agencies can negotiate terms to meet their needs
Agencies also need to know they can negotiate how they want to receive payments with their acquiring bank. They can opt for a single monthly payment instead of receiving a settlement for each transaction. This simplifies the entire process and alleviates major concerns agencies have on this topic, which stems from the misconception that each transaction needs to be settled in their bank account.
Being the merchant of record is not a burden for the agencies
There’s another myth regarding agencies as the Merchant of Record (MoR). The truth is that agencies can benefit from taking on the responsibilities of being a MoR, and it’s no different from any other type of transaction they typically handle, like e-commerce or retail transactions.
Characteristics of being a MoR:
- Riders see the agency as the service provider on their bank statements – this drastically decreases requests for chargebacks.
- Recognizable to the cardholder as the merchant that sells purchased goods or services – this drastically decreases requests for chargebacks.
- Direct relationship with the payment processor or payment facilitator – allowing for negotiation of better deals.
- Own risk and liability of all transactions processed – the transit transactions have almost no claims, and fraud is close to 0 based on the acquirer statistics.
- Provides direct cardholder customer service, giving the agency full flexibility regarding support, which can also be outsourced to the vendor.
- Incorporates cardholder terms and conditions approved by the Schemes listed on the website – completely standard procedure.
The challenges with discretionary discounts and open-loop technology
Bank cards can be used for discretionary discounts in open-loop, but this comes at a cost. A common case is when a transit agency wants to offer discretionary discounts to eligible riders to use their bank cards to travel.
There are two approaches for solving this problem:
1. The more common approach is to ask the riders to go through a registration/association process and eligibility check so that the system will recognise that the card should not be charged per trip.
2. The other approach is for the agency to sell/issue White-Label EMV cards that are not part of the banking systems but use the same structure, and again have an eligibility check.
Technically, this is closed-loop processing. While both approaches would work, they add unnecessary complexity to the transit system and, in the second case, with the White-Label EMV cards, more expensive cards than needed.
People often assume that the media determines whether or not a system is open or closed-loop. This isn’t the case when it comes to discretionary discounts.
An account-based ticketing system could solve multiple issues for agencies
Another way these projects fail is when agencies neglect to consider passengers who use discounted travel passes, which is most riders. This involves discounted passes for a day, weekly, and monthly. Frequent riders will likely rely on monthly passes when traveling, as they offer the best value. A group of users would be inclined to pay with their bank cards, but when presented with various other options, such as QR codes and mobile ticketing, the convenience of the bank cards is getting lost.
The best approach for agencies is to use an account-based ticketing system capable of incorporating both open-loop and closed-loop processes equally. This way, the system will operate with tokens regardless of whether a rider uses an open-loop bank card, any sort of closed-loop card, or a QR code. In this case, the agency will have complete flexibility in deciding the most optimal fare handling and what is most convenient for the riders.
Final Thoughts
We need to look at open-loop technology as an enhancement to traditional closed-loop systems, not a replacement. Open-loop systems are a natural next step to help transit agencies cater to user preferences and demand by adapting to additional fare collection methods. If open-loop systems are integrated with closed-loop processes, adoption rates could be significantly higher. Through this, agencies can expand their options and naturally shift or limit the use of cash. With the adoption of payment platforms such as Apple Pay and Google Pay, more people will start to rely on their bank cards as they won’t be required to reach into their pockets or wallets to grab a physical card. Instead, they can simply use their phone, something that’s already in their hands, resulting in a better overall experience.
