Variation to the MasterCard and Visa Access Regimes: Details-stage
Regulation Impact Statement – March 2014 5. Impact Analysis

This section discusses the likely impact of each option. The directly affected private parties are likely to be MasterCard, Visa and current and prospective scheme participants. Businesses and consumers that use card payment systems are likely to be indirectly affected by the degree of competition in the delivery of card payment services that each option is able to provide. APRA will also be affected by the cost of applying the SCCI regime in each option.

It should be noted that because the proposed options involve considerable uncertainty around the likely number of new entrants under each option, the way in which each scheme will respond and the precise effects of increased competition, the ability for likely impacts to be quantified is limited. The regulatory burden and cost offset estimates have been calculated using the Business Cost Calculator on an annual basis.

Option 1: Maintain the Status Quo

This option would retain the current MasterCard and Visa Access Regimes and continue to rely on ADI/SCCI status to determine eligibility to participate in the schemes. It has been used as the benchmark for considering the costs and benefits of the other options.

Benefits

Maintaining the status quo provides clear and objective entry criteria that are set by a regulator. Because the criteria for entry are relatively high and ongoing prudential supervision is applied by APRA, this option is likely to result in the least risk from system participants to the card systems among the options considered.

This option also means that assessment of participant risks is centralised with APRA, potentially reducing the need for assessment processes to be conducted in parallel by both MasterCard and Visa for some entities (although MasterCard and Visa have noted that they already undertake their own assessment of individual participants under the existing framework – for example to impose collateral requirements).

The above benefits primarily accrue to the card schemes and incumbent participants, which benefit from this option where they bear some of the cost and reputational risk arising from a participant default. Incumbents also benefit from reduced competition relative to the other options.

By maintaining the Access Regimes, Option 1 provides a mechanism for a person denied access to ask the Reserve Bank to give a direction, and the right to apply to the Federal Court for an order for compliance and/or compensation. This benefits potential entrants.

Costs

The costs of Option 1 are the direct regulatory costs to SCCIs and reduced competition in the card issuing and acquiring markets. The former largely affects SCCIs, while the latter ultimately affects the users of the payments system – consumers, businesses and government.

Regulatory costs

SCCIs will face higher costs than otherwise. Those applying for SCCI status will face application fees and the cost of undergoing assessment by APRA, along with the cost of changes to governance and operations that might be in excess of what would otherwise be required to undertake the business. If granted authorisation, SCCIs face ongoing fees and administrative costs of compliance with the SCCI regime, along with the costs of meeting regulatory requirements such as minimum capital requirements on an ongoing basis. Many responses to consultation have expressed a view that these costs are higher than warranted for the nature of the business undertaken.

Reduced participation and competition

Because the costs of entry are likely to be higher under Option 1 than otherwise, fewer entities will join the systems as participants, reducing competition among card issuers and acquirers. Further, some entities may be ineligible to participate regardless of costs, for instance because of ownership restrictions imposed by the Banking Act on ADIs. The limited new entry of SCCIs that has occurred since the Access Regimes were introduced is prima facie evidence that the current regime is in practice quite restrictive. The Bank is aware of several entities that have considered applying for SCCI status but have considered the costs too high.

Limiting participation in the MasterCard and Visa systems will deny users of those systems – consumers, business and government – the benefits of stronger competition. The price of card payments is therefore likely to be higher than otherwise. It is not possible to quantify the magnitude of this effect; average acquirer margins (estimated by the mark-up of merchant service fees over interchange fees) for MasterCard and Visa credit card transactions have fallen from 59 basis points to 27 basis points over the period that RBA access regulation of card systems has been in place. Reduced participation also means that competition via improved services or innovation is likely to be reduced. For instance, the virtual card products proposed by several prospective entrants have the potential to significantly improve the efficiency of payments and reconciliation for businesses operating in the travel industry. Other potential entrants may offer improvements in efficiency for other types of payments system users.

Public sector costs

The current arrangements also result in costs for APRA and the Reserve Bank in its provision of services to the Commonwealth Government.

Authorisation and supervision of SCCIs places demands on APRA's supervisory resources. This occurs even though SCCI risks do not fit within APRA's core mandate; cardholders generally do not face risks from the MasterCard and Visa systems and risks within those systems are not of a magnitude to generate systemic risk.

The Access Regimes also prevent the Reserve Bank itself from participating in the MasterCard and Visa systems, since it conducts banking business under the Reserve Bank Act rather than as an ADI. This may prevent it from delivering payment services (e.g. acquiring) to the Commonwealth Government in the most efficient way possible. As noted above, there is no similar constraint on Reserve Bank participation in the eftpos system. This raises the prospect of inconsistent treatment of card schemes in Australia and potential detriment to inter-scheme competition.

Option 2: Remove the APRA SCCI Regime, but Retain Some Controls via the Access Regimes

Under this option, the Access Regimes would be varied to widen the range of entities eligible to participate in the MasterCard and Visa systems. As noted, Banking Regulation 4 would need to be removed, meaning that the SCCI category of ADIs would no longer exist. ADIs and entities that were SCCIs at a specified date (‘former SCCIs’) would remain eligible to participate and the schemes would have the discretion to also allow additional types of entities to participate. Schemes would be required to make public their risk-based criteria for determining which additional entities would be eligible and which eligible entities would be admitted, and to report annually to the Reserve Bank on how they had used this discretion and on their compliance with the Access Regimes.

There are two possible ways in which MasterCard and Visa could respond under Option 2. They could decide only to allow participation by ADIs and former SCCIs, meaning that entry is not expanded (scenario 1) or they could decide to admit additional types of participants, which would bring with it an obligation to publish risk-based criteria for entry (scenario 2).

Benefits

Scenario 1

Under scenario 1, the benefits relative to Option 1 largely flow to existing SCCIs, who would no longer be subject to the ongoing costs associated with APRA regulation, including fees, administration and reporting costs and the need to hold higher capital than might otherwise be necessary.

Scenario 2

The benefits under scenario 2, where the schemes choose to admit additional participants, are more significant, affecting current SCCIs and prospective entrants, as well as users of the card systems (consumers, businesses and government).

As under scenario 1, current SCCIs will benefit from reduced regulatory costs arising from APRA regulation outlined above. New entrants that would have achieved SCCI status in the future under Option 1 will also gain those benefits, and would no longer face the one-off costs of the initial APRA assessment and authorisation process. These cost reductions are estimated to be approximately $1.6 million per year, on average, for a participant that would otherwise have been required to become an SCCI.^[1] There may be some offsets to the extent that MasterCard and Visa impose more rigorous standards and compliance processes than under the status quo. These are nonetheless likely to be more flexible and tailored for different types of card payment businesses than APRA's requirements on ADIs, resulting in a lower net cost to participants than under Option 1. Many submissions, including from the schemes, argued that the APRA SCCI regime is more onerous and restrictive than warranted by credit card business.

Other potential participants will benefit by being able to directly undertake MasterCard and Visa acquiring and issuing business where they could not currently. In part this benefit could be approximated by the fees charged by an existing participant to provide issuing and acquiring services to a third party. However, in consultation, a number of parties indicated that the principal costs of not being able to participate are the constraints imposed on that party's activities if they are forced to operate via a direct participant, such as constraints on the volume of business or the card schemes that it may deal with. It is not possible to estimate this cost (and hence the benefit provided by Option 2 in allowing these parties direct access).

As well as benefiting SCCIs and potential participants, scenario 2 would additionally provide increased competition in issuing and acquiring and therefore greater efficiency in the payments system. This would benefit users of the payments system, including businesses, consumers and government. These parties are likely to face lower card payment costs as a result, along with benefits from improved services (e.g. acquirers offering more features to merchants) and innovation (e.g. the introduction of niche products such as ‘virtual’ credit cards). It is not possible to quantify these benefits.

This option would also allow MasterCard and Visa to choose to admit the Reserve Bank as a participant, resulting in a more consistent treatment of card schemes in Australia, given that the eftpos system is already able to accept the Reserve Bank as a member. This would potentially allow the Reserve Bank to provide payment services more efficiently to the Commonwealth Government.

APRA would no longer bear the cost of authorising and supervising SCCIs, allowing it to better direct supervisory resources to its core mandate. Note that these cost reductions are not considered by the OBPR to be compliance costs for the purposes of the regulatory burden and cost offset estimates in the table below.

In light of the Reserve Bank's objective of appropriately balancing the benefits and risks of greater participation in the MasterCard and Visa systems, an important benefit of Option 2 is that it increases accountability of schemes' access policies and practices through the transparency of eligibility and assessment criteria and through reporting to the Reserve Bank. This reduces the potential for the schemes to impose and apply arbitrary criteria or discriminatory practices, or to excessively relax risk standards.

Like Option 1, both scenarios under Option 2 provide a mechanism for a person denied access to ask the Reserve Bank to give a direction, and provide the right to apply to the Federal Court for an order for compliance and/or compensation.

Costs

Scenario 1

Scenario 1 would result in few costs if the schemes chose not to admit participants beyond ADIs and existing SCCIs. Given that the two existing SCCIs will no longer be subject to APRA supervision, the schemes might choose to conduct more intensive ongoing monitoring of their financial position than currently. This implies some additional cost to MasterCard and Visa in relation to those two entities, though it can be assumed that the cost for the SCCIs would be more than offset by the removal of APRA compliance costs (reflecting the fact that APRA regulation is considered to be more onerous than necessary for credit card business). Other incumbent participants and users of the systems would be little affected by this scenario.

Scenario 2

The costs of Option 2 under scenario 2 (i.e. MasterCard and Visa admit new types of participants) fall largely on MasterCard, Visa and potentially existing participants.

Because under this option former SCCIs and any new non-ADI members (or potential members) will no longer be supervised by APRA, a greater onus will be placed on the schemes to assess and manage participant risk. While the schemes have stressed that they already perform this function, there may be some increase in costs for incremental activities to be undertaken in the absence of APRA supervision. These costs are likely to depend on the types of members admitted; for instance costs may be lower where the only additional members admitted are those subject to prudential regulation in another jurisdiction. Given that these costs will depend upon the approaches taken by the schemes, they cannot be estimated at this time.

If the schemes choose to admit participants beyond ADIs and former SCCIs, they will be required by amended Access Regimes to publish eligibility criteria and report to the Reserve Bank each year on how they have applied those criteria. This will result in administrative costs for the schemes.

The nature of Option 2 is that MasterCard and Visa will only admit additional entities if the benefit to the schemes outweighs the costs of doing so. Nonetheless, MasterCard and Visa have expressed different opinions on the materiality of potential additional costs.

A further cost is the potential for greater risk to be introduced to the systems by admitting members that are not prudentially supervised. The failure of a participant to meet its settlement obligations within the system has the potential to affect the scheme and other participants. The net of the failed participant's obligations would need to be absorbed in the system; how this occurs would depend on the arrangements in each system. Both MasterCard and Visa argue that they have strong member assessment and risk management systems in place. The use of collateral requirements, tailored to the profile of the participant, is an important element of this.

The incentives faced by the schemes are important when considering the risks that might be introduced by relaxing new entry. The schemes' primary interest is in generating transaction flows, which generate fee revenue. Transaction flows in turn rely on the size of the network; that is, the number of cardholders and merchants, which is supported by the number of issuers and acquirers. Allowing additional participants is likely to increase transaction flows. However, if existing participants become concerned about facing additional risk as a result, or reputational damage from a participant failure affects adoption by end-users, this might ultimately be detrimental to the network.

Regulatory burden and cost offset estimate

Net benefits and costs under Option 2

The Bank's objective is to enhance competition and efficiency in the card payment systems by encouraging broader participation. This will be achieved under Option 2 by the schemes choosing to admit new types of members beyond ADIs and former SCCIs. While the schemes bear additional costs in admitting new types of members, by doing so they would indicate that the benefits to them outweigh the costs. Competition benefits will not be achieved if the schemes opt not to extend membership beyond ADIs and former SCCIs. Nonetheless there will be a reduction in regulatory costs for former SCCIs and APRA, with limited additional costs for the schemes in relation to the two former SCCIs.

There are a number of factors that suggest that a material increase in risk from reducing access restrictions is unlikely:

• the schemes have an incentive to ensure that their respective systems remain attractive to participants, including by controlling risk
• this option does not compel the schemes to expand membership from the current arrangements; if they consider that the admission of entities not subject to prudential supervision gives rise to unacceptable risks, they will not admit them
• the schemes argue that they have robust participant screening and risk management mechanisms in place, including the use of collateral.

The Bank's assessment is that Option 2 offers net benefits relative to Option 1 regardless of which scenario plays out.

Option 3: Remove all Access Regulation

The third option is the complete removal of the Access Regimes, leaving access entirely in the hands of the schemes. Once again, this option would only be effective if Banking Regulation 4 was removed so that issuers and acquirers of credit cards were no longer required to be ADIs.

Under this option, access arrangements would be the same as prior to the reforms in 2004. That is, the ability of current SCCIs or new entrants to participate would be determined solely by the schemes' willingness to admit them.

Because Option 3 places all discretion in the hands of the schemes, there is uncertainty about outcomes. The two scenarios outlined in Option 2 are possible, as is admission only of ADIs, thereby excluding former SCCIs.

Benefits

The benefits of this option are similar to those under Option 2, with the schemes having the ability to either retain current access arrangements or to admit additional types of participants.

If the schemes choose to allow participation by ADIs and current SCCIs only, benefits would flow largely to current SCCIs since they would no longer be subject to ongoing costs associated with ARPA supervision; the schemes would also benefit from having lower compliance costs than the status quo.

Should access be extended to entities that would not currently be eligible, benefits would flow to current SCCIs, prospective participants, as well as end-users of the card systems. Both SCCIs and new entrants that would have achieved SCCI status would no longer face regulatory costs associated with ongoing APRA supervision; the latter would also benefit from not having to pay the one-off costs associated with the SCCI assessment and authorisation process. Other potential participants will also benefit by being able to directly issue and/or acquire MasterCard and Visa transactions where they could not currently. Competition and innovation will be increased, promoting greater efficiency in the payments system. This would benefit the schemes and new entrants as well as consumers, business and government, who are likely to face lower prices, improved service and increased product choice.

In either case, this option would provide the benefits of reducing APRA's costs of authorisation and supervision, enabling it to better direct supervisory resources to its core mandate. Aggregate benefits may nonetheless be offset to the extent that the schemes choose to undertake any additional assessment and monitoring.

Finally, the removal of all access regulation may increase the schemes' ability to exercise judgment in granting membership relative to Option 2. While Option 2 allows the schemes to determine eligibility and assessment criteria, it may be difficult for those criteria to anticipate the full range of entities that may apply for membership in the future.

Costs

By removing all access regulation for the MasterCard and Visa systems, this option does not impose any costs directly on any party. However, to the extent that the schemes choose to utilise the freedom to admit additional members, a greater onus will be placed on them to assess and manage participant risk, potentially giving rise to costs for both new entrants and the schemes. The costs to the schemes of changing any eligibility and assessment procedures as a result would therefore be similar under Option 3 to Option 2 (these would not be classified as compliance costs). As noted, prospective participants will seek membership and the schemes will grant it only if each sees a net benefit in doing so.

Like Option 2, Option 3 has the potential to increase risk in the MasterCard and Visa systems by allowing entry of entities that are not prudentially supervised. The failure of a participant to meet its settlement obligations would mean that the net shortfall would need to be absorbed by the scheme or its participants. As discussed under Option 2, this risk is mitigated by the fact that the schemes have an incentive to maximise the size of their respective networks, including by maintaining the confidence of participants in the level of risk entailed. The schemes argue that they have robust participant screening and risk management mechanisms in place and should they have concerns about the risk implications of expanding membership, Option 3 (like Option 2) does not compel them to do so.

The principal drawback with Option 3 is greater uncertainty about the range of outcomes and therefore greater policy risk. In particular, whereas Option 2 guarantees the eligibility of current SCCIs and therefore that competition will not be reduced from current levels, this is not true of Option 3. For example, a scheme seeking to rely solely on ADI status for membership eligibility would not be required to extend eligibility to former SCCIs.

Also unlike Option 2, Option 3 offers no transparency and accountability on the part of the schemes in relation to their access policy. As a result, there is little to prevent the schemes from granting access in an inconsistent or arbitrary way. For instance, while the schemes may welcome new entry, they could be expected to focus on the potential entrants that offer the greatest commercial advantage or where membership in Australia is part of a broader relationship. Other parties might find access difficult simply because they are not a high priority for the schemes, rather than the schemes being opposed to their participation. A number of parties during consultation expressed concern about how the schemes might utilise any additional discretion provided to them. Compared with the other options, prospective participants are therefore more likely to face a greater level of uncertainty under Option 3. This is likely to have greater bearing for smaller prospective participants, given their limited capacity to generate large volumes of card transactions and therefore revenue for the schemes. Such an outcome would be detrimental to competition and limit product choice for consumers and merchants, particularly in non-traditional payment products.

Finally, Option 3 does not provide any recourse under the Payment Systems (Regulation) Act for a prospective participant unreasonably denied access. Because there is no Access Regime, a person denied access cannot ask the Reserve Bank to give a direction, or apply to the Federal Court for an order for compliance and/or compensation.

Regulatory burden and cost offset estimate

Net benefits and costs under Option 3

While increased access relative to Option 1 and lower regulatory costs than both Options 1 and 2 are possible under this option, there is greater uncertainty, including a possibility that access is reduced relative to the other two options. The absence of any recourse under the Payment Systems (Regulation) Act for parties that have been unreasonably denied access also weighs against this option. While indications from the schemes that they favour wider access suggests that this option would increase competition, this option also has a possible outcome of a reduction in competition; this uncertainty of outcomes means that it is not possible to conclude with confidence that this option is superior to either Option 1 or Option 2.

Footnote

One-off costs are amortised over 10 years. [1]