Octopus extends its reach

The Octopus smart card is a force to be reckoned with. But its success relies on stringent and effective cash management procedures.

Everyone in Hong Kong knows the Octopus card. That clever little piece of plastic that stops commuters on the public transport system from fumbling for change. They don't even need to get it out of their wallet. If the card is positioned correctly, one quick swipe with a wallet or bag and voila - they're through to catch that train.

There are 6.4 million Octopus cards on issue. That's a staggering amount, considering that HSBC and Standard Chartered have each issued just over 1 million credit cards in Hong Kong.

The company behind the contactless smart card is Creative Star Limited (CSL), which was granted a deposit-taking licence by the Hong Kong Monetary Authority (HKMA) in April. That authorization will broaden the range of uses for the card, for which CSL has ambitious plans.

CSL is a private non-profit company, whose shareholders are the major transport providers of Hong Kong û the Mass Transit Railway Corporation (MTRC), the Kowloon Canton Railway Corporation (KCRC), the Kowloon Motor Bus, Citybus and New World First Bus. Incorporated in 1993, CSL began with the purpose of operating a common ticketing and payment system for fares on the MTR, the Kowloon-Canton Railway cross-country train, the Kowloon Motor Bus routes that run between Kowloon and Hong Kong Island, and the Hong Kong Ferry routes.

Tentacles everywhere

From a cash management point of view, the Octopus card poses a challenge. Some 6.4 million Octopus cardholders add value to their cards via an increasing variety of load agents. The core load agents are the transport service providers, which have 'add-value' machines at stations. Other load agents include Seven-Eleven convenience stores; Electronic Payment Services Company Ltd (EPSCO), which transfers money from specified bank accounts to the Octopus card; and local bank Dah Sing.

Dah Sing is the first and so far the only bank to provide a fully automated 'add-value' service. That means, when there is not enough deposit to cover the cost of a journey, the holder's Dah Sing bank account is automatically debited by HK$250 and the sum credited to the Octopus card. This is all done with one quick swipe at the turnstiles.

The average amount on each card ranges from HK$63 to HK$65. That means there is a whopping HK$416 million ($53.3 million) deposited in the Octopus system. On average, a cardholder will add HK$100 at a time to their card. And according to CSL, the load agents collect approximately HK$30 million per day. That HK$30 million goes through a four-layer computer recording system. At the first layer, reader devices installed at the turnstiles will record the transaction. That information is then transmitted to the localized data processor at the station and then to the service provider's central computer system. The final layer is CSL's central clearing system. The central clearing system generates a daily activity report on that specific reader, showing what value of transaction has transpired that day.

Before settlement between the transport service provider and CSL takes place, there is a 'netting off' of the daily amount that is collected by the load agents, and the transactions recorded by the four-layer system. According to Kenneth Tan, financial director of CSL, historically, the 'add-value' amounts and the transaction amount is about even. "If we are over or under, it will not be in appreciable amounts."

Settlement between the transport service provider and CSL is then made within 24 hours via HSBC's Hexagon system. Settlement means CSL makes a payment to the service provider based on the netted amount. If the transaction value exceeds the add-value amount, funds are drawn from a 'buffer' current account that CSL holds to pay the transport service provider. The amount kept in CSL's current account is based on historical patterns of daily expenditure. The 'buffer' pool of funds is either put into a savings account, short-term deposit accounts or short-term bonds.

The second 'tier' of cash that CSL holds is in accordance with the minimum liquidity requirement set out by the HKMA. Any funds deposited by Octopus cardholders over and above that operating layer is then invested. However, there are stringent investment rules by which CSL has to abide. "As we are a deposit-taking company [DTC], we have to comply with certain rules of the HKMA ... our investments are driven with the objective of capital preservation in mind, so there are no risky investments made," says Tan.

CSL has been investing funds in certificates of deposits, bonds (up to 5 years), debt paper of rated public sector corporations of Hong Kong, and multilateral development banks, such as the Asian Development Bank. Most of the investments are made in Hong Kong dollar denominations. "There is no intention for us, for example, to venture into foreign currency paper. Our base is in Hong Kong and there is no need to involve ourselves in exchange risk," says Tan.  "But we are permitted to venture into US denominated investments à and that is a possibility for us in the future."

CSL's prime revenue model is fee based. For shareholder service providers, the fee is at a cost basis. For non-shareholders, CSL charges a nominal fee based on the merchant's Octopus card-related turnover.

A smart future

The Octopus Card was previously exempt from the definition of 'multi-purpose' card under the Hong Kong Banking Ordinance because its use was restricted to transport-related sectors. The exemption meant that only up to 15% of its transaction values could come from non-core activities. But does the deposit-taking licence granted by the HKMA to CSL mean that the Octopus card will become ubiquitous? Will the Octopus card evolve to become a general-purpose debit card like Mondex, or Visa Cash? After all, CSL has an existing customer base. Other e-cash cards have had a slow uptake because of a lack of critical customer mass, and because of the multitude of platform standards.

But CSL is cautious about expansion. "We are a multi-purpose card now, but only in a limited way. Our major focus is still transport related à our expansion plans are geared towards the small-value, high-volume type of transactions," says Tan.

He also dismisses the idea that Octopus will eventually compete in the e-cash arena. "We are venturing into other areas primarily for the sake of cardholders' convenience." One of the non-core areas where CSL is making headway is the school tuck shop. School children at Wah Yan College in Kowloon can now swipe away with the Octopus card for their lunchtime treats. Adults, too, can partake at a Maxim's fast food franchise in Central or at Maxim's cake shop. "We are also hoping to do something with an organization like McDonald's," says Tan.

CSL is considered a leader in the smart card stakes in Asia, having won numerous awards for its innovative card. But Tan says that CSL has no immediate plans to license the concept. "We are essentially Hong Kong based à we have no plans right now to expand beyond that." But he admits that the Shenzhen municipal government has shown an interest in the Octopus card, and "we are in very preliminary-type discussions".

Going public with an IPO is also not in the immediate future for CSL, according to Tan. "We have our hands full right now," he says, as he uses the Octopus card as a security badge to let himself back into the office after the interview - showing yet another use for the card.