The RBA has issued a paper outlining the proposed scope of a review of card payments in Australia. Given the evolution of payments, the rise of new payment platforms, weaknesses in the current interchange arrangements, payment surcharging and changed economics in the payments value chain, this is timely. Submission on aspect of the Bank’s card payments reforms, should be provided by no later than 24 April 2015.
The RBA outlines a number of factors which indicate a review is needed:
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Aspects of the interchange fee system and merchant surcharging practices have raised concerns, some of which were noted in the Board’s 2013 Annual Report and the Bank’s two submissions to the Financial System Inquiry (FSI).
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There have been some significant changes to the regulation of card payments in other jurisdictions.
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The completion in 2014 of the Bank’s third Consumer Use Survey and second Payment Costs Study have provided a useful evidence base for considering possible changes to policy.
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The continuing growth in the role of cards in the payments system since the initial reforms underscores the need for an appropriate regulatory framework for such payments.
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Interchange arrangements in the card systems will also affect the nature of new payment arrangements that are adopted by the payments industry. In particular, a more efficient and lower-cost new payment system might be hampered in its development to the extent that it had to match existing interchange payments to card issuing institutions to ensure the participation of banks in the new system.
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The FSI has made recommendations directed at the Bank and its regulation of card payments, with particular focus on interchange fee regulation and surcharging.
The Payments System Board would be interested in hearing the views of stakeholders about the issues raised in the previous chapter and possible changes to the regulatory framework that might address those issues.
Some of the possible changes to the regulatory framework are along the lines of those suggested in the Final Report of the Financial System Inquiry (FSI). The Final Report endorsed the broad nature of the Bank’s reforms over the past decade or more. In particular, the Report stated that ‘the Inquiry believes interchange fee caps improve the efficiency of the payments system. Without interchange fee caps, price signals for customers are less clear and outcomes are less efficient because customers can be encouraged to use higher-cost payment methods’ (FSI 2014b, p 171). In addition, the Final Report stated that ‘the Inquiry agrees with the RBA that surcharging can improve the efficiency of the payments system by providing accurate price signals to customers’ (FSI 2014b, p 175).
However, the Final Report noted a few areas where the Inquiry believed the existing regulatory framework could be improved. These included lowering the existing interchange fee caps and broadening their application, and improving the accuracy of price signals in surcharging and the enforceability of mechanisms against excessive surcharging. The FSI Final Report took a holistic view of the card systems, just as the Bank’s earlier reforms have recognised the interlinkages between different aspects of the operations of the card systems. One example is that the Report’s recommendations on surcharging were linked to its recommendations on interchange fees. In particular, the surcharging recommendations reflect the idea that if it was possible to promote the availability of low-cost methods of payment for consumers and merchants, the case for merchants retaining the right to surcharge for those low-cost methods of payment would be reduced.
Specific Issues for Consultation
The Board is interested in the views of stakeholders on the following issues.
With respect to the regulation of interchange fees, the Board is interested in views on the following options:
- Publishing thresholds for which payment system providers will be subject to interchange or related regulation, possibly based on transaction values and/or market shares. The FSI Final Report suggests that that this would give new entrants and existing providers greater certainty about how regulation will be applied and would enhance competitive neutrality between providers. Such thresholds could potentially apply to providers such as American Express, as well as other international schemes such as UnionPay, if they entered the domestic market. Thresholds might also be applied for surcharging regulation and could potentially apply to providers such as PayPal.
- Broadening interchange fee caps to include other payments between schemes and issuers. There are a range of payments (such as marketing fees, sign-on fees, incentive fees and rebates) from schemes to issuers that are used in both three- and four-party schemes. These other payments can potentially be used to circumvent interchange caps: for example, a four-party scheme can increase fees charged to acquirers and use these funds to pay rebates to issuers, mimicking an interchange payment. Similarly, rebates or incentives paid by a network to an issuer in a companion card arrangement can achieve similar outcomes to an interchange fee. The FSI Final Report suggests that broadening the current interchange fee caps to apply on a broader functional basis would help prevent circumvention of interchange caps and enhance competitive neutrality in the case of companion card arrangements. Regulation of other incentive payments has already been implemented for debit cards in the United States, and is proposed for both debit and credit card schemes in the new EU payments regulation.
- Making changes to the interchange benchmark system to reduce the upward ‘drift’ in average interchange rates inherent in the current three-year reset cycle. One option would be to shift to more frequent benchmark observance, such as annually or even quarterly. This would ensure that average interchange rates were much closer to the benchmark, though this might not have much effect on the tendency for the gap between the highest and lowest interchange rates to widen.
- Lowering interchange caps. The FSI Final Report suggests that payments system efficiency could be enhanced by lowering interchange fee caps, with the benefits including lower product prices for all consumers as a result of lower merchant service fees, and less cross-subsidisation in the payments system.
- Replacing weighted-average interchange caps with hard caps. The FSI Final Report notes that weighted-average caps allow schemes to set interchange schedules which imply relatively high payments costs for smaller merchants without market power and low costs for larger merchants. In addition, the widening in the range of interchange fees raises questions about the transparency of costs for many merchants. Furthermore, the current system of observance of the caps has meant that weighted-average interchange fees in the MasterCard and Visa systems have typically been above the caps. In the new European Union (EU) payments regulation previous settlements reached with MasterCard and Visa, constraining interchange fees for cross-border consumer credit card transactions to 30 basis points per transaction or a maximum weighted-average cap of 30 basis points respectively, will be replaced by a hard cap of 30 basis points on all credit card transactions.
- Applying caps as the lesser of a fixed amount and a fixed percentage of transaction values. The FSI Final Report suggests that applying a fixed percentage cap for debit cards, in addition to a fixed-value cap, would ensure low interchange payments on low-value transactions which would promote merchant acceptance. The use of a dual percentage/value cap has also been proposed in the new EU payments regulation, where debit card interchange could be capped at the lower of 20 basis points or a fixed-value cap which member states may set at their own discretion. In the case of credit cards, the FSI Report notes that the introduction of a fixed-value cap would be a significant change and that a transition period might be warranted if it were adopted.
- Including prepaid cards within the caps for debit cards. As noted above, there is a degree of ambiguity in how prepaid cards are dealt with under the interchange benchmarks. Accordingly, it would be helpful to clarify this in a review.
- Allowing for ‘buying groups’ for smaller merchants to group together (subject to any competition law restrictions) to negotiate to receive the lower interchange rates that are accessible to larger merchants. This option might be considered in the event a future interchange system continued to generate large differences in the interchange rates faced by different types of merchants. A similar measure was part of a settlement between US merchants and MasterCard and Visa in 2012, although that agreement only requires that card companies meet with merchant buying groups, and not that card schemes must offer similar rates to merchant groups that bring similar transaction volumes.
With respect to surcharging, the Board is interested in views on the following options:
- A tiered surcharging system, perhaps along the lines of the FSI recommendations. The FSI Final Report suggests that a three-tier approach would be likely to reduce cases of excessive surcharging by providing merchants with clearer surcharging limits that will reduce problems with enforcement in the current system. Alternatively, other variants of a tiered system might be appropriate. The FSI Final Report proposal would include:
– Allowing low-cost system providers to prevent merchants from surcharging, to encourage consumers to use low-cost payment methods. The Final Report suggests that systems would qualify as low-cost if their interchange fees were below the caps for debit systems (or if three-party systems were equivalently low-cost in terms of merchant service fees). Given the widespread holding of debit cards, this would imply that essentially all consumers would be able to make card payments (presumably including in the online environment) without being surcharged.
– Allowing medium-cost providers to limit surcharges to limits set by the Board. The Final Report suggests that schemes would qualify as medium-cost if their interchange fees were below credit card interchange fee caps (and three-party systems could qualify if their merchant service fees were equivalent to those of other medium-cost providers). The limit set by the Board might be based on average card acceptance costs. Such limits would be published, which would ensure that it was immediately observable to card schemes, consumers and others if a merchant was surcharging excessively – this would enhance the enforceability of such limits.
– Allowing high-cost providers to limit surcharges to the reasonable cost of acceptance. Such providers would also be required to disclose that they were high-cost providers so that their customers would understand why they were likely to be surcharged. The reasonable cost of card acceptance would be based on the costs of the particular merchant, meaning that there would remain scope for dispute over whether a merchant was surcharging excessively.- Targeted changes to reduce particular cases of excessive surcharging. The two industries where concerns about surcharging are most vocal are the taxi and airline industries. Surcharging in the taxi industry is becoming the focus of most state taxi regulators. In the case of the airlines, the current fixed-dollar surcharges would appear to be well above the reasonable cost of card acceptance for low-value fares, given that the costs associated with credit cards are typically mostly ad valorem or percentage-based. Accordingly, a simple measure might be to modify the Bank’s surcharging Standard or Guidance Note to allow schemes to cap any surcharges that are not percentage-based at some low fixed-dollar amount. This could result in a significant reduction in surcharges payable on lower-value fares. It is possible that a change such as this, which would be largely independent of potential other changes to the regulatory framework, could be made relatively quickly.
- Any other changes to enforcement procedures and disclosure practices. Where merchants wish to surcharge for particular high-cost payment instruments it is important that any charge should be properly disclosed up front and that there is at least one non-surcharged method of payment that is generally available to consumers. The Board is interested in stakeholder views regarding the extent to which these requirements are met by merchants and also in more general views as to mechanisms by which excessive surcharging or incomplete disclosure of surcharges might be addressed.
The Board is also interested in views on some other possible regulatory changes that could improve the way that market forces operate in the cards system:
- Strengthened transparency over the cost of payments to merchants and cardholders. To the extent that there continued to be large differences in interchange rates on cards from a particular system, it would seem important for merchants to know the cost of accepting a card at the time of the transaction, so they can make informed decisions regarding acceptance or surcharging. Greater transparency would also be important for consumers to enhance their understanding of whether they are using a low-cost card or a high-cost card that may be surcharged. Measures to improve transparency could include:
– Ensuring that debit and credit cards are more readily identifiable by merchants electronically.
– Requiring, as in the new EU payments regulation, that categories of cards with different interchange fees should be identifiable both visually and electronically, so that consumers and merchants are aware when a high-cost card is being used.
– Requiring, as in the EU payments regulation, that acquirers must offer merchants pricing and billing that separately shows the interchange fee and merchant service charges that apply to each brand and category of cards. While many Australian merchants are now subject to ‘interchange-plus’ pricing for each scheme, others are still subject to blended rates, including between debit and credit, and some merchant statements do not promote a good understanding of card costs borne by merchants.- Further easing of ‘honour-all-cards’ rules to allow merchants to decline to accept cards with high interchange fees. The current restrictions on honour-all-cards rules allow merchants to make separate acceptance decisions on debit versus credit, but could be extended to allow merchants the freedom to decline high-cost cards within a particular scheme.
- Facilitation of differential surcharging by merchants. To the extent that the acquiring market was not providing the ability for merchants to surcharge differentially based on the nature of the card, it might be desirable to explore measures that would require card schemes and acquirers to provide merchants with such ability to differentiate. This might be supplemented, as in the EU proposal, with controls on scheme rules or contractual terms that prevent merchants from informing consumers about the cost of interchange fees or merchant service charges: this would mean that Australian merchants could not be prevented from informing customers of their cost of card acceptance if they wished to justify their surcharging policies.
- Ensuring that merchants have the ability to choose to route their transactions via lower-cost networks or processors. This might involve requiring, as is the case for debit cards in the United States, that acquirers must route transactions through the network which the merchant has nominated as their preferred option among those networks available on a card. This could provide some offset to the tendency for competition between schemes to drive interchange fees higher. A stronger option, as will be required in the EU payments regulation currently being considered, would be that the scheme activities and processing infrastructure of card networks are legally separated, so as to facilitate competition in the market for processing transactions.
- Clarifying arrangements for competing payment options within a single device or application. One option might be along the lines of the proposed EU payments regulation concerning ‘cobadging’ and choice of payment application. Regulatory measures might include restrictions on scheme rules that prevent the inclusion of other payment brands or payment applications on a device (e.g. mobile phone) or that may prevent different payment options being included within a payment application. The proposed EU payments regulation also requires that security standards or technical specifications, and arrangements for routing transactions, should be applied in a non-discriminatory manner when handling two or more different payment brands or applications on a single device. Similarly, providers of payment services might be required to allow merchants or cardholders the option of specifying their own preferences regarding the priority of different networks or payment methods, both on co-badged devices and in mobile wallet applications.
Finally, the Board is also interested in stakeholder views on the appropriate regulatory arrangements for prepaid cards.
General Issues for Consultation
The Board expects that stakeholders may wish to raise other issues concerning card payments and their role in the broader retail payments system. Accordingly, it encourages stakeholders to suggest any additional measures that the Bank should consider in a review of the regulatory framework. The Board will also take account of any relevant responses to the Government’s current consultation on the recommendations in the Final Report of the Financial System Inquiry.
The Board recognises that some of the possible regulatory changes discussed above (e.g. changes to the interchange fee caps) could imply significant changes to business models in the cards industry while other possible changes (e.g. to improve the transparency of costs to merchants) could imply significant systems changes by schemes and acquirers. It will be mindful of these issues as the Review proceeds. However, the Board notes its concerns about the existing cards model which results in most merchants facing significant variability in the cost of card transactions within the four-party schemes, while having no visibility over these costs at the time of the transaction. Similarly, merchants have limited or no ability to respond to these differences by charging differentially or declining to accept high-cost cards. Accordingly, the Board encourages stakeholders to suggest measures that could address its concerns in ways that would minimise adjustment costs for the payments industry.
During the 2007–08 Review, the Board and the Bank spent a considerable amount of time exploring a non-regulatory approach whereby voluntary undertakings from schemes in relation to interchange fees could serve in place of formal regulation. As noted above, ultimately industry participants were unable to arrive at arrangements that the Board considered were in the public interest. International experience also suggests that non-regulatory solutions have been difficult to achieve. Furthermore, the option of removing interchange fee caps was touched on in the Interim Report of the FSI (FSI 2014a, p 2-31) but not endorsed by the Final Report (FSI 2014b). The Board sees challenges in a nonregulatory approach, but would nonetheless be interested in stakeholder views on approaches that could result in a sustainable framework that met the Board’s concerns and were in the interests of competition and efficiency in the Australian payments system.
Finally, while it is important that any changes to the regulatory system should occur in a way that recognises all the interdependencies, the Board is interested in views about whether there are particular targeted changes, for example to the surcharging framework, that could usefully occur ahead of any more general package of reforms.
