Strengthening E-Commerce Payment Systems Amid Insolvency Risks

The payment process of e-commerce transactions between buyers and sellers typically involves payment originators such as card companies, payment gateways (PGs), e-commerce platforms, and issuers of e-payment instruments, including mobile vouchers and e-coupons.^[1] Payment gateways not only relay buyers’ payment information received from platforms to credit card companies but also act as a representative merchants for many subordinate vendors by serving as their payment agents. The payment gateway directly linked to the payment originator is referred to as the primary PG, and the platform company subordinated to the primary PG is called the secondary PG. Sales proceeds are settled to vendors through the payment originator, primary PG, and the secondary PG.

When multiple payment gateways are involved in the payment process, those closer to the payment originator are assigned higher numbers (e.g., PG1, PG2, etc.). Mobile vouchers and e-coupons are considered prepaid e-payment instruments (prepaid e-money) since consumers purchase them in advance of ordering goods.^[2] The sales of these prepaid instruments have steadily increased due to promotional discounts offered by issuers. Some companies, like Ticket Monster, may simultaneously operate as a payment gateway, issue their own prepaid e-money (e.g., TIMON Cash), and act as sales agents for third-party prepaid e-money (e.g., Happy Money). Consequently, the payment gateway representing the seller of a voucher may differ from the payment gateway representing the affiliate network of the same voucher.

Figure 1: A Simple Diagram of E-Commerce Settlement Structure

Note: 1) Credit card transactions are processed in the following sequence: ① placement of order ② approval of payment ③ receipt of order ④ delivery of goods ⑤ settlement of payment ⑥ card fee payment. 2) Prepaid e-money transactions are processed in this sequence: ⓐ purchase of e-money ⓑ placement of order ⓒ transmission of order and payment order ⓓ delivery of goods ⓔ settlement of payment. However, the order of ⓓ and ⓔ may vary depending on the transaction. 3) Each diagram represents the simplest structure of payment settlement, so the structure could be much more complex and extended in reality.

The insolvency of prepaid service providers or subordinate PGs could destabilize the entire settlement system, causing losses to:

1. Consumers unable to refund their prepaid e-money.
2. Consumers unable to cancel or refund their payment orders.
3. Vendors who have not received settlement payments.
4. Payment originators and upper-level PGs who have already processed cancellations and refunds.

Consumers face non-performance risks from the moment they place an order (or purchase e-money for prepaid transactions) until the transaction concludes with the receipt of goods. Vendors, on the other hand, are exposed to non-performance risks from the time they deliver goods until their accounts are settled. For certain products, such as travel packages, which take time to complete the transaction from the moment of contract, losses may affect both consumers who have already paid and vendors who have committed to provide the service. For instance, total losses could exceed the payment amount if both the consumer and travel agency bear the costs of non-cancellable orders and pre-booked accommodations.

Card companies and primary payment gateways may also suffer losses if lower-level payment gateways become insolvent after payments have been settled but before the expiration of the cancellation and refund period. To mitigate such risks, extending the settlement cycle may be necessary.

Regarding user protection for e-financial services, the revised Electronic Financial Transactions Act, effective September 2024, seeks to ensure consumer refunds for prepaid e-money through mandatory separate management of prepaid charges. The revised bill requires 100% of prepaid charges to be separately managed by depositing or entrusting them to financial institutions or subscribing to payment guarantee insurance. In the event of insolvency, consumers are granted priority reimbursement rights. Separately managed prepaid charges may only be utilized in safe ways defined by the enforcement decree. As a result, even if prepaid e-money becomes inaccessible due to the insolvency of a prepaid service provider or its agent, consumers should still be able to receive refunds from the provider managing the funds.

The revised bill also includes measures to strengthen the financial soundness of prepaid service providers, such as expanding the registration scope and limiting promotional discount sales based on their debt ratios.

The discussion of mandatory separate management of sales proceeds, due to the Ticket Monster and WeMakePrice crisis, is significant as it highlights vendor protection, a topic previously overlooked. While the exact extent of damages is yet to be calculated, unsettled payments to vendors—especially those with high transaction volumes and two-month settlement cycles—are expected to exceed consumer losses. The EU’s Payment Services Directive II (PSD2), which includes provisions to protect payment service user funds, covers both consumers and vendors. Similarly, Japan’s Payment Services Act mandates the protection of prepaid charges and requires the deposit of sales proceeds. Payments for ongoing transactions, such as those subject to cancellation or refund, are classified as user funds and must be managed separately. This approach helps mitigate the risk to card companies and upper PGs from accelerated payment settlements.

The mandatory separate management of sales proceeds is also anticipated to enhance the financial stability of e-financial service providers. Weak prudential controls were identified as a primary factor in the current crisis. However, establishing uniform prudential standards across e-financial service providers is challenging due to differences in business areas, asset sizes, performance, and models. Nevertheless, protecting sales proceeds at a level comparable to the management of prepaid charges could reduce the incentive for providers to delay settlements, thereby lowering unsettled balances and improving overall financial soundness. Management guidelines under the E-Financial Transactions Act require e-financial service providers to maintain: (i) a capital adequacy ratio of 20% or more against the outstanding balance, (ii) an asset ratio of 100% or more in low-risk investments against the outstanding balance, and (iii) a current assets ratio of 50% or more against current liabilities.

Crucially, the legal framework for e-financial services must clearly define and allocate liabilities among providers while mandating user protection duties. The current crisis raises concerns about how the general settlement structure with multiple PGs will handle consumer cancellation and refund requests. Under the E-Financial Transactions Act, PGs are considered e-financial service providers, whereas the Specialized Credit Finance Business Act classifies them as merchants. This discrepancy creates potential confusion about the scope of PG responsibilities. To assign and allocate liabilities effectively, a clear understanding of the superior-subordinate relationships (or consignment arrangements) between service providers is necessary, along with the assignment of rights and management obligations to subordinate companies (trustees). Additionally, the possibility that costs associated with the separate management of sales proceeds may be passed on to small vendors as service fees must be addressed.

Given the collapse of these two e-commerce giants, it is imperative to establish clear responsibilities for payment service providers to address potential challenges in the e-payment system and prevent future crises.

^[1] For simplicity, this article assumes that platform companies handle simple payments and related functions to facilitate consumers' access to various payment methods.

^[2] Here, “goods” refers to both goods and services.

Korea Institute of Finance website.