Understanding Closed Loop and Open Loop Payment Systems: Regulatory Implications Under UAE Law

Payment systems have evolved into two main categories: Closed Loop and Open Loop, each offering distinct functionalities and regulatory requirements. Closed Loop systems create a direct relationship between the end user and the service provider, often for specific merchants or locations, while Open Loop systems allow broader transaction capabilities across multiple networks.?

Understanding the differences between these two systems is crucial, especially within the regulatory framework of the UAE. Open Loop systems are regulated and require licensing from the Central Bank of UAE (CBUAE), while Closed Loop systems, due to their minimal risk, are exempt.

This article explores both payment systems and examines their legal treatment under UAE law, focusing on the regulatory implications of the CBUAE’s Retail Payment Services and Card Scheme (RPSCS), Stored Value Facility (SVF), and Open Finance regulations.

Closed Loop payment system

A Closed Loop payment system operates without intermediaries, establishing a direct relationship between the end parties and the payment system. This system provides prepaid access to funds that can only be used for transactions involving a specific merchant or location, such as a particular retailer, transit passes or store gift cards.

Closed loop cards are restricted to purchasing goods or services from designated merchants, and funds cannot be withdrawn or converted into cash, only stored credit is provided for returns.?

Similar to Open Loop payment processing, a Closed Loop systems integrate software, hardware, and financial infrastructure to facilitate transactions within a specific ecosystem. The process begins when a customer initiates a payment – whether through a physical card, mobile app, or another authorized method. The system verifies the customer’s payment information, and checks for sufficient funds in the closed loop account. If verification and fund availability are confirmed, the transaction is authorized, and funds are transferred from the customer’s account to the merchant's account within the closed loop ecosystem.?

Closed loop cards are commonly used for branding, increasing sales, and engaging customers. For example, airline loyalty points that can be redeemed for flights or upgrades but not for cash, and reward points that can be used in specific stores.

Open Loop payment system

Open loop payment systems support a wide range of transactions and involve intermediaries such as banks and licensed financial institutions, enabling payments across various networks for broader merchant acceptance.?

When a purchase is made, the payment gateway encrypts the cardholder's information, and the processor submits it to the card network (e.g., Visa, Mastercard) for authorization, transferring funds from the customer's account to the merchant's bank.?

Open loop prepaid cards, typically branded by major networks like Visa, Mastercard, or American Express, can be used universally for payments.

Unlike closed loop cards, open loop cards allow cash withdrawals, and refunds can be issued as cash or other forms of payment, not restricted to store credit.

Closed Loop and Open Loop under UAE law

Open Loop payment systems whether under Retail Payment Services and Card Scheme Regulations (RPSCS) or Stored Value Facility (SVF) or Open Finance Regulations require a license from the Central Bank of UAE (CBUAE)

However, whenever a payment system is operating as a Closed Loop, it is exempted from obtaining any license from the CBUAE since it poses nearly no risk on customers or their funds and the financial system. For example:

Under RPSCS:

A payment transactions and related services between a parent undertaking and its subsidiary or between subsidiaries of the same parent undertaking, without any intermediary intervention by a Payment Service Provider other than an undertaking belonging to the same group.

Under SVF:

• SVFs can be used for certain cash reward schemes, allowing users to store money paid by the issuer or a party with an agreement with the issuer. The stored funds are limited to specific terms and can only be used to pay for goods or services provided by the issuer or the agreeing party. Examples include loyalty schemes in shops or supermarkets that offer cash rewards for customer loyalty.
• (SVFs) can be used for bonus point schemes, storing points or units that represent Money’s Worth provided by the issuer or a partner. Customers can use these points to pay for goods or services from the issuer or partner, either entirely with points or combined with temporarily stored funds for payment purposes. These funds are not redeemable for cash. Examples include as mentioned above, airline mileage programs and customer loyalty schemes, where non-cash points are awarded and cannot be exchanged for cash.
• SVFs can be restricted for use within a limited group of goods or service providers. These SVFs can be used to make payments only to the issuer or to a person who provides goods or services under an agreement with the issuer.

Under Open Finance regulations:

Data Sharing and Service Initiation services licensed under Open Finance regulations apply only to activities regulated by the CBUAE. Activities outside the CBUAE's regulatory authority are not subject to these regulations. For instance, if a company provides Data Sharing or Service Initiation services related to Closed Loop operations, which are exempt from CBUAE licensing, those services and the associated rights and obligations, such as access to data or accounts, would not be governed by the regulation.

Conclusion

The evolution of payment systems highlights the growing importance of both Closed Loop and Open Loop models in various sectors.?

Each system serves distinct purposes, catering to specific business needs and customer preferences, from loyalty programs to universal payment solutions. Under UAE law, the regulatory framework ensures that Open Loop systems are closely monitored to protect users, while Closed Loop systems, due to their limited scope, enjoy regulatory exemptions.?

However, Closed Loop systems are not risk free. The lack of transparency regarding how stored credit are managed and safeguarded can raise concerns among users about the security and proper handling of their stored credit within these closed environments. Moreover, it is certainly possible to use closed loop systems for Money Laundering and Financing Terrorism (for instance, if a terrorist group collects store gift cards and uses them to purchase equipment), yet the restrictive characteristic of the Closed Loops makes them less attractive to illicit actors.?

Ultimately, the UAE’s approach seeks to balance innovation and regulation, allowing the financial ecosystem to thrive across the region while ensuring consumer protection. For businesses, this means an opportunity to leverage Closed Loop systems for customer engagement and branding while staying mindful of the inherent risks. Open Loop systems, on the other hand, offer the convenience and flexibility of universal payment solutions that span across various merchants and services.?

It is important for businesses navigating this landscape to understand the dynamics and nuances of these payment systems, enabling them to leverage each effectively while ensuring regulatory compliance in the UAE.