Acquiring gambling merchants is high risk. Or at least this always used to be the case. But in a regulated industry quick to adopt new technology, where the house always wins, how high risk is acquiring gambling merchants nowadays?
Humans love to gamble. The first pair of dice was discovered in an ancient Egyptian tomb dating from around 3,000 BC. The ancient Chinese used tiles in games of chance. Indians circa 1,500 BC loved betting on chariot races. Gambling — as well as attempts to prohibit it — have been part of human history from even before the first casinos in 17th century Italy and the invention of the one-armed bandit in the 1890s. But is an industry founded on managing its risks actually high risk to acquire?
THE LUCK OF THE DRAW
Gambling is playing games of chance to win money. Yet the definition is as short as the scope of the activity is broad. Gambling encompasses everything from buying a raffle or lottery ticket, entering a sweepstake to playing bingo. It includes betting on horse races or other sporting events, visiting casinos, and playing fruit machines, arcade games or other gaming machines.
The gambling industry generated around $365 billion worth of profits in 2016, according to H2 Gambling Capital (H2G), a specialist research firm. Online gambling is the fastest-growing sector, accounting for 11 percent of profits. One of the most lucrative markets for gambling is Australia, which began to deregulate the industry in the 1980s. Betting losses per resident adult in Australia amounted to $990 last year. That is 40 percent higher than Singapore, the runner-up, and around double the average in other western countries, such as Ireland and Finland, H2G figures say.
In gambling, the numbers can get very big very quickly. A large, well-established online gambling merchant can process $90-120 million per month on average on cards, according to one industry observer. If the merchant also runs physical betting outlets, accepts alternative payments and is multi-acquired, this can be significantly higher. This dwarfs a typical large e-commerce merchant with average monthly card takings of $5 million. Gambling profits and volumes are high. But what about the risks?
The main risks within the gambling sector are money-laundering, fraud and regulation. Gambling products could be used for money transfer between people colluding with one another and/or with the house. Regulatory requirements vary between jurisdictions, but know your customer (KYC) checks routinely conducted on players at registration and for pay-outs over certain amounts aim to prevent money-laundering. Some gambling authorities also restrict pay-outs to the payment method used to charge the account. Others require operators to prevent players choosing their tables in online poker or similar games.
“The gambling industry is usually at the forefront of using new technologies to mitigate risks and understand payments.” Dave Excell, Featurespace
The gambling sector experiences fraud risks, as any other. Fraudsters may monetise legitimate identities by creating and using online gambling accounts fraudulently. A legitimate customer may also charge gambling transactions back, claiming they did not make them. This type of ‘friendly fraud’ on payment cards takes on a particular cast with VIP players, depositing 30-40 gambling transactions a month over several months. Repudiated transactions in these cases could amount to hundreds of chargebacks, triggering card scheme chargeback thresholds.
Merchants may be able to defend such chargebacks by providing compelling evidence of cardholder participation. Yet it still counts in their fraud and chargeback ratios, leaving them open to potential acquirer fines or withdrawal of their payment facility in a worst case scenario. It is unlikely that one VIP customer could so adversely impact a large operator. However, smaller to mid-sized operators are more vulnerable.
Regulatory risks arise if a merchant does not have the appropriate gambling licence or adhere to the terms of their licence. Licensing regimes vary according to jurisdiction, and while not the same, there are similarities. “You have all the basic principles: to verify the associated games on the platform, to vet the associated directors and beneficial owners [of the operator], to run KYC, to impose customer due diligence at the time of pay-out to ensure that no money-laundering happens,” explains Christian Chmiel, CEO, Web Shield, a risk management company.
Gambling merchants and those who acquire them have to keep abreast of regulatory changes. It is a dynamic space as the growing importance of online and mobile channels has led many countries to re-evaluate gambling legislation. The cross-border nature of remote transactions complicates matters and heightens risk. Moreover, card scheme rules require transactions to be legal in both the country of the cardholder and merchant to be entered into interchange.
For example, remote gambling has been regulated at the point of consumption in the UK since November 2014. As such, gambling websites trading with, or advertising to, consumers in the UK must be licensed by the UK Gambling Commission. Any operator offering remote gambling services to UK consumers without a UK Gambling Commission licence is acting illegally.
So much for the main gambling sector risks. But whose risks are they? Who owns and is responsible for managing them?
“The majority of the risk is with the gaming operator,” says Dave Excell, chief technology officer and co-founder of Featurespace, an adaptive behavioural analytics company spun out of Cambridge University. “There’s the financial loss associated with fraud. There’s the operational cost of making sure that these things are managed correctly. There’s also the reputational risk if an operator is associated with lots of bad transactions. That has a negative connotation to customers, but also within the industry,” he says.
In some senses, gambling is inherently risky, Excell maintains. A gambling operator is very good at managing those risks to make a profit for themselves. That is what the organisation is built around — risk management — and understanding the different types of risks that can exist. This ranges from understanding how card games work, setting odds and preventing people from gaming the system. “The gambling industry is usually at the forefront of using new technologies to mitigate risks and understand payments. They are always trialling new and emerging technologies and using that as a competitive advantage,” says Excell.
How exactly? “Within a gambling organisation, there is a tremendous amount of data to understand what the customer is doing. We work with the gambling operator to manage the lifecycle of the customer,” says Excell. This covers customer acquisition, registration, funds deposit and gambling behaviour. Factors such as how much the customer wagers, how quickly and the types of bets placed, help to build a picture of the player.
There are also factors explicitly around payment, such as the different sources used to fund the account, frequency of top-ups and payment data cross-checked against IP and device details. This provides information about the legitimacy of the customer. It also guides insights into whether they are a recreational player, or someone who may become a problem gambler or a future fraud liability.
Being cognisant of and able to manage money-laundering, fraud and regulatory risks — their own risks — is table stakes for any gambling operator. Competitive advantage comes from how they manage these risks and differentiate themselves not only to customers, but also in the back-office with their use of people, processes and technology.
SEE YOU AND RAISE YOU
Acquirers need to understand the gambling operators’ risks and how they are managing them to evaluate their own risk exposure. Naturally, acquirers also face risks of their own. The main ones are variants of those faced by their merchants, particularly around the complexities of anti-money laundering and regulatory requirements.
How gambling is marketed is also important for the assessment and management of acceptance risks. If a merchant’s sales and marketing practices violate applicable laws, transactions for legal services may become illegal. As gambling is commonly cross-sold via adult entertainment affiliates, acquirers face the second-order consequences of heightened affiliate fraud risk.
Acquirers face operational risks. Correspondent banks are de-risking settlement of US dollar funds to gambling merchants, even if the transactions were not performed by US citizens. For example, if a French citizen places a US dollar bet on a website operating entirely legally, acquirers may have difficulty settling the transaction onward to their merchant in US dollar, industry insiders confirm.
Acquirers are also more open to negative balances with gambling merchants. They may owe issuers more than the issuers owe them, either due to refunds, chargebacks or original credits used for payment of winnings. If the gambling merchant is multi-acquired and switches transactions between acquirers, the exposure to negative balances increases, particularly if acquirers become liable for more pay-outs than they have accepted in wagers. Naturally, acquirers can recoup any shortfall from their merchants, but they would be exposed for a certain period and their liquidity affected. Acquirers should implement mechanisms to limit outgoing flows to the merchant. This helps prevent negative balances without approval and automates top-ups from the merchant, whether in the form of additional collateral and/or rolling reserves.
These and other general acquirer risks notwithstanding, gambling merchants are not considered high risk by many acquirers. Indeed many acquirers target gambling business to help balance fraud and chargeback ratios within their portfolios. Gambling is a high-volume sector with play happening within a limited timeframe, so traditional credit risks and chargebacks arising from non-receipt of goods or services are negligible.
Chargeback rates for gambling merchants are similar to those of large retailers. They are certainly much less than for adult and nutraceutical merchants and those using membership-based marketing models. Moreover, the larger the gambling operator, generally the lower the fraud and chargeback rate. Such operators tend to have more resources and invest more in technical systems to better manage their risks.
CARDS ON THE TABLE
Is acquiring gambling merchants actually high risk? “Yes, it is high risk if you don’t understand the business, how the traffic is generated, how the games work, and solely rely on the licence provided by the merchant,” says Chmiel.
Gambling merchants require a certain type of management. If acquirers are able to do that, it is more business-as-usual than high risk. Acquirers are potentially more exposed to risk if they underwrite merchants, whose businesses they do not fully understand. After all, unaddressed risks are more dangerous than known risks mitigated with the appropriate controls.
What is the position of the card schemes with regard to gambling merchants? Both Mastercard and Visa categorise gambling merchants as high brand-risk, if not high risk, largely because it is to them. They have programmes in place, including registration requirements for acquirers active in the gambling sector. This is to protect their own brands and systems from financial and reputational risks as much as it is to protect the acquirers from such risks.
The reality of high-risk, or indeed any, acquiring is nuanced at the macro level, and the schemes are in a difficult position. They must manage their own risks, but also balance the interests, rights and responsibilities of clients participating in their system. It is challenging to create a common understanding around risk and how it is best managed across borders, cultures and risk appetites.
For some acquirers, high-risk acquiring may be analogous to smoking cigarettes. There are those who enjoy smoking and have no intention of quitting. They know it may be bad for their long-term health and the health of others around via passive smoking, yet they wish to continue. Dealing with the small minority of organisations, which are aware of the rules, consciously flout them and prioritise evading detection over compliance is a difficult balancing act.
PCM asked both major card schemes about the nature and ownership of gambling risks and how they engaged with acquiring clients to mitigate risk and protect the integrity of the payment system. A Mastercard spokesman advised engaging with the acquirers as they held the direct relationships with the gambling sector.
Both major card schemes fine clients who have been found to be non-compliant with scheme rules. As commercial organisations, they could be seen to benefiting from the behaviour of bad actors. Firstly from the volume and any associated click fees from purchases and pay-outs, and secondly from fines. How did the schemes counter claims around the perception of a conflict of interest when dealing with non-compliance among their clients?
“Our operations comply with both national law and EU requirements and we enforce a strict set of rules that forbid the use of a Visa payment mechanism to buy an illegal product or services,” said Visa Europe in a written statement.
ALL BETS ARE OFF
We apply probability to almost every conscious decision we make. From taking an umbrella on assessment of the weather to choosing when to cross the road. The whole of the gambling industry is founded on judgements around the balance of probabilities or risks. It may happen or it may not. Either way, it matters because it will have an impact, whether positive or negative. Good, well-run gambling operators know and understand this — and take active steps to manage their own risks. So do good, well-run acquirers.
Those serious about acquiring gambling merchants need to take it seriously. Continuously establishing the context, identifying, analysing, evaluating and treating risks are the fundaments of risk management. Acquiring gambling merchants is not something any acquirer can dabble with in the corner of their portfolio. It is not about rolling the dice.