Counsel Corner: Navigating the Future: Legal Insights on FedNow's Impact on the Digital Economy and for Fintech Companies

Our Counsel Corner series brings together the top legal minds from our community to discuss complex challenges that GCs face when growing their companies and navigating their careers. In this blog post, we will hear about the legal and regulatory considerations relevant to FedNow from Jess Cheng, Partner at Wilson Sonsini Goodrich & Rosati PC and former senior counsel at the Federal Reserve Board of Governors where she led the drafting of the federal regulations governing FedNow instant payments, and Peter Wei, Head of Legal at Octaura.

In a world where digital commerce moves in the blink of an eye, the ability to instantly send and receive money at low cost is becoming more than an advantage, but a necessity. FedNow is the long-awaited new service for instant payments created by the Federal Reserve where money moves from one bank account to another, with settlement and receipt of final funds happening in near real-time. The new system is a much-needed upgrade to the national infrastructure for retail payments, which is currently closed on weekends and can at times take several days before funds are available. With FedNow, individuals and merchants have faster access to their funds and greater flexibility to manage cash flow, at low cost, and with reduced payment risk. FedNow has the potential to revolutionize digital commerce and the fintech companies that support it, particularly if they can be first movers.

Potential Effects on the Legal Landscape

FedNow creates opportunities for fintech companies in the evolving U.S. payments space. Although eligibility for FedNow is limited to U.S. banks, fintech companies, and other non-bank payment providers have a critical role to play in rolling out the end-user interfaces needed to make FedNow payments convenient and safe, offering the processing services that many banks rely on, and integrating instant payments into platforms and products that drive the digital economy.

To take advantage of the faster movement of money enabled by FedNow, fintech companies will need a solid understanding of the service’s key features. With that comes an increased role for the General Counsel to ensure their operations and systems adhere to the nuances of FedNow and evolving payments law. Companies need to be proactive about the potential risks and increased harms that come with implementing new technologies and changing regulation.

The launch of the FedNow Service in 2023 marks a significant turning point in the U.S. payments industry and a rare window of opportunity for innovators. Especially because of the heavy regulation and fast-moving change sweeping the industry today, General Counsels have a tremendous impact in the payments space. Nailing down the foundational legal principles of the U.S. payment system can help General Counsels strategically capitalize on evolving regulation and changing customer preferences. - Jess Cheng

The speed, finality, and around-the-clock operation of the FedNow Service can pose unique challenges to staying one step ahead of bad actors and increasingly sophisticated fraud schemes and cyberattacks. That said, not all change is negative – in this case, it can be an opportunity for innovation. Cheng suggests that understanding the legal ramifications of FedNow can be a competitive advantage in the industry and help companies keep up with the fast pace of the payments industry. In her view, General Counsels can set up their companies to stay competitive by staying informed on the areas to innovate and offer tailored functionality within the bounds of FedNow’s legal terms.

To capitalize on the benefits of FedNow, General Counsels have an important role to play in helping their companies:

1. Adopt a holistic strategy to understand and mitigate risks
2. Educate teams on legal requirements
3. Monitor policies to ensure compliance with consumer protection laws

According to Peter Wei, companies can also save on costs when utilizing FedNow because of its “competitive expediency, availability, and current discounts.” They should review their current payment service contracts to account for the benefits of FedNow.

Strategic Recommendations for GCs

In preparing for the shift towards instant payments, it is not necessary to entirely reinvent the wheel. Many companies in this industry have established fraud prevention processes, anti-money laundering (AML) controls, sanctions screening procedures, and consumer protection measures for traditional payment methods, such as debit cards, credit cards, and ACH. For fintech companies assessing their readiness and risk controls for instant payments over FedNow, Cheng highlights the following considerations:

Query whether existing risk management measures and controls are appropriate for payments over the FedNow Service (especially given its speed and around-the-clock operation, as well as given that use cases that customer behavior for instant payments may diverge from traditional payment systems).

Make sure to understand the applicable law for instant payments, which differ in critical aspects from what practitioners accustomed to traditional funds transfer systems (such as ACH and wire transfers) or card network rules might expect.

Not all controls that are currently in place to monitor AML, fraud, and cyberattacks should necessarily be applied in the same way to instant payments over FedNow and new ones may become more important. Re-evaluating the risks with FedNow, tailoring the controls to the new risk assessment, and having a handle on relevant laws and regulations, will help ensure compliance.

Relevant legislation and rules include:

• Electronic Funds Transfer Act
• Regulation E
• Regulation J, which incorporates Article 4A of the Uniform Commercial Code

General Counsels should consider bringing in experienced outside counsel to help mitigate risks and secure a competitive advantage in their field. A holistic perspective, including informed by the expertise of outside counsel, on the broader legal atlas and regulatory change on the horizon can be an invaluable asset in an otherwise complex and evolving landscape.

Strategies for Specific Sectors:

E-commerce Merchants - Navigating New Payment Systems: Legal leaders of e-commerce merchants must conduct a legal risk analysis against existing payment rails, including by updating agreements with their banks to accommodate a FedNow relationship. Attention to operational burdens, potential delays, and dispute resolution processes is crucial.

Digital Wallet Companies - Ensuring Compliance and Innovation: Digital wallet companies review their current terms to ensure protection against increased risks associated with expedient fiat wallet balance funding. Legal leaders must navigate additional legal terms imposed by banks and negotiate compliance, considering the heightened operational, legal, and compliance risks associated with around-the-clock operations.

Changes to Agreements and Relationship Evaluation

General Counsels should also consider changes to their existing agreements bank and potential disclaimers for delays when using FedNow, as well as, the preferred dispute resolution channel for FedNow issues. Companies' relationships with banks may change when using FedNow so it is important to evaluate your relationship with your bank and any new legal terms set out by the bank itself.

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