Reform of the EFTPOS and Visa Debit Systems in Australia:
Final Reforms and Regulation Impact Statement – April 2006 10. Implementation and Review

10.1 Changes to the draft Standards and Access Regime

Following its decision that competition and efficiency in the payments system would be promoted by the implementation of Standards regarding interchange fees in the Visa Debit and EFTPOS systems and the honour all cards rule in the Visa Debit system, and of an Access Regime in the EFTPOS system, the Bank considered various options for these Standards and the Access Regime. Most of these options were raised during the consultation process.

EFTPOS Access Regime

The Bank considered the arguments for alternative methodologies that would deliver a higher cap on the amount an existing participant could charge a new participant for providing a direct connection. This followed submissions that the proposed methodology was unfair to the existing institutions. The proposal by First Data International (FDI) was that existing participants should be able to recover all the costs they incur in providing a new connection.^[1] Under this option, there would be no enforceable cap, but an indicative benchmark based on average connection costs of existing participants. The Australian Bankers' Association (ABA) proposed that any access regime should allow all existing participants to recover all their costs of providing access.^[2]

Both the FDI and ABA proposals would significantly increase the cost of entry and reduce the scope for increased competition. The benefits would accrue to existing participants, especially those with less flexible systems. In the Bank's view, setting the cost of a connection such that high-cost existing participants receive compensation for all their costs of establishing a new connection is not in the public interest. Such an approach could put new entrants at a significant disadvantage and would do little to encourage existing participants to develop more efficient access arrangements.

FDI also argued that, when providing connections to relatively small participants, it effectively provides additional consulting services and that the cap on access charges in the Access Regime could prevent it from recovering the costs of doing so. In the Bank's view, this is not a matter for the Access Regime, as the Regime deals just with the cost of establishing a ‘Standard Service', as defined in APCA's Access Code. If an existing institution is providing consulting services there is no reason that it could not charge separately for these services.

A second access-related issue considered by the Bank was the provision in APCA's Access Code that would allow a firm to take advantage of the Code provided it were prepared to establish two direct connections within 12 months and a third direct connection within three years. While this provision is not part of the Bank's Access Regime, the Bank had strongly urged APCA to adopt it, rather than one that would have required a higher minimum number of connections to be eligible.

In reaching a view as to the appropriate minimum number of connections, the Bank took account of the interests of both new and existing participants. An increase in the minimum number of connections may dissuade entry, or make entry more costly. The result may be less competition than might otherwise take place. On the other hand, if there were fewer participants with direct connections, there would likely be fewer total connections, and thus lower costs for participants in establishing and maintaining the system.

On balance, the Bank was not convinced that the cost savings that might result from fewer institutions establishing direct connections outweighed the potential adverse effects on competition. In reaching this view, the Bank recognised the possibility that an increase in the number of institutions seeking direct connections may prompt the industry to consider evaluating the potential alternative access arrangements under which there would be a single point of access. Such arrangements often exist in overseas payment systems in which there are many participants.

The Bank's view is that the trade-offs struck in the draft Access Regime and APCA's Access Code are appropriate.

Given the above considerations, the Bank has not made any material changes to the proposed Access Regime for the EFTPOS system and is not requesting that APCA make any changes to its draft Access Code. It has, however, made some minor drafting changes to the Access Regime. The definition of a debit card has been changed following comments received in consultation. In particular, the definition now refers to a deposit account held at an authorised deposit-taking institution, rather than at the participant that issued the card. The Access Regime now also uses APCA's term of ‘self-acquirer', rather than ‘merchant principal'. Finally, the drafting of paragraph 16 has been altered to provide for the possibility that the survey may be slightly different in detail from that conducted by APCA in 2004.

The Access Regime is set out on pages 34 to 37.

EFTPOS interchange Standard

A number of submissions suggested changes to the EFTPOS interchange Standard.

One option considered by the Bank was to reduce the interchange fee to zero. While this option had considerable appeal, the Bank viewed it as raising considerable legal risks, given the uncertainty over whether a requirement to set the interchange fee to zero would meet the legal test of a ‘standard'. Given this legal uncertainty, the Bank did not consider this option further. The Bank also considered setting a common interchange fee but again elected not to do so, given the legal uncertainties surrounding such an approach.

A second option considered was to reverse the current EFTPOS interchange fees so that any fees would be paid by acquirers to issuers. The Bank, however, does not believe that a convincing economic case for moving these fees past zero has been made.

A third option considered was to allow separate interchange arrangements for transactions involving cash out and those involving just a purchase.^[3] This option was suggested by merchants and appears to be mainly relevant to merchants with high volumes of cash receipts, such as large supermarkets, which provide the option of cash out to customers. As discussed earlier, these merchants are typically paid a fee by their bank for EFTPOS transactions and lowering the interchange fee is likely to result in them receiving a smaller, or even no, fee for EFTPOS transactions. The merchants argued that this would tip the balance against the economics of providing cash out, with the result that they may no longer offer this service. They further argued that, since interchange fees for ATMs are not currently regulated, the same should be the case for EFTPOS transactions involving cash out.

In the Bank's view, the arguments for exempting cash out from the Standard are finely balanced.

At the margin, the proposed Standard, if implemented, would not materially affect merchants' incentives to offer cash out. For most EFTPOS transactions involving cash out, merchants currently do not receive any incremental revenue; the same interchange fee and merchant rebate apply on a transaction involving just a purchase as on a transaction involving a purchase and the provision of cash. The only case in which incremental revenue is earned is where cash is provided without a purchase being made; in this case the merchant earns the same rebate as for any other EFTPOS transaction. This situation would remain unchanged under the proposed Standard. As a result, as is the case now, the decision to offer cash out would be driven primarily by cost considerations and consumer demand.

Notwithstanding this analysis, the Bank recognises that for many people the withdrawal of cash through the EFTPOS system and an ATM are close substitutes. Given that, at this stage, the Bank has decided not to regulate interchange fees in the ATM system, there is a case to apply the same approach to cash out through the EFTPOS system.

On balance, the Bank is not convinced that the overall efficiency of the payments system would be improved by regulating the interchange fee that issuers pay acquirers for transactions involving cash out. Accordingly, the Standard has been amended so that it does not apply to transactions involving cash out. For these transactions, issuers and acquirers are able to negotiate an interchange fee that differs from the interchange fee on purchase-only transactions.

A fourth option considered by the Bank was a modification of the definition of eligible costs. This follows the argument by the merchants that the costs of purchasing or renting PIN pads should be included in eligible costs. Some merchants also argued that the time taken at the checkout to process an EFTPOS transaction, over and above that taken to process a cash transaction, should also be included in eligible costs on the basis that the merchant is providing a banking service to banks' customers. As noted in the previous section, some merchants also argued that their investment in the system would suffer if they could not earn a return through rebates from acquirers. It was also argued that the costs of all nominated acquirers should be taken into account in calculating the benchmark, not just those of the three acquirers with the lowest costs.

The Bank was not persuaded by these arguments. The Bank's view is that interchange fees are appropriately viewed as a device to balance the costs and revenues of issuers and acquirers to promote efficiency, rather than a means for one side of the transaction to compensate the other side for specific costs. The Bank's decision to proceed with an interchange standard reflects a view that lower EFTPOS interchange fees would promote a more efficient payment system and that, given other interchange fees in the system, the EFTPOS interchange fee should be reasonably close to zero.

The Bank's decision to use cost-based standards – with eligible costs defined with respect to just one side of the market – reflects the fact that such an approach is transparent and meets the legal test of a ‘standard'. The use of this approach should not be interpreted as the Bank endorsing the idea that interchange fees should be used to compensate one side of the market for either all, or a particular subset, of its costs.

Given this, the Bank sees no case for expanding the range of eligible costs in the EFTPOS interchange Standard or for including the costs of higher-cost acquirers. Including the cost of PIN pads and taking account of the acquirers' costs of all nominated participants would increase the interchange fee in the EFTPOS system (relative to the draft Standard), potentially unwinding some of the beneficial effects discussed above.

Among remaining issues, CUSCAL argued that the floor under the EFTPOS interchange fee would prevent it from negotiating a more favourable interchange fee. The Bank weighed this possibility against the benefit of the floor in constraining negotiations over interchange fees from being used to frustrate access to the system. It is not making any changes to this aspect of the Standard.

A further issue raised by Coles Myer was that the draft Standard could preclude it from participating in terminal-sharing agreements, such as those that some bank acquirers have with American Express. Under these agreements, American Express provides the terminal and facilities for merchants to accept cards. The merchant, however, has a separate acquirer for transactions undertaken on cards other than American Express and this acquirer typically pays American Express a fee for capturing the transaction and switching it to the acquirer. The agreements between American Express, as the terminal owner, and the acquirers are not subject to the standard, since these are agreements between acquirers, not between acquirers and issuers.

Finally, the Bank considered the suggestion that any changes to EFTPOS interchange fees should be delayed until 2007 when the Bank is scheduled to begin its review of the effects of the credit card reforms. However, the Bank does not see a case for further delays to reform of the debit card systems, particularly given that any changes flowing from that review are unlikely to come into effect until 2009.

Given the above considerations, the only material change the Bank is making to the EFTPOS interchange Standard is with respect to transactions involving a cash out component. In particular, paragraph 9 of the Standard has been altered to give effect to the exclusion of cash out. The Bank has also made the same change in definition of a debit card as in the Access Regime and likewise used ‘self-acquirer' in place of ‘merchant principal'. There are also minor changes to improve clarity.

The EFTPOS interchange Standard is set out on pages 38 to 40.

Visa Debit interchange Standard

A number of submissions also suggested changes to the Visa Debit interchange Standard. Most of these suggested alternative methodologies would result in a smaller reduction in interchange fees compared to the draft Standard.

One option considered by the Bank was to base the Standard on the eligible costs of current issuers of Visa Debit cards, rather than on costs calculated as part of the credit card interchange Standard. A second option considered was to include fraud-related costs in the Standard. A third option was to calculate the benchmark described in clause 14 of the Standard on the basis of the average cost per credit card transaction, rather than per debit card transaction as the Standard currently does. Data available to the Bank suggest that if all these options were adopted, the interchange fee in the Visa Debit system would be capped at around 37 cents, rather than around 15 cents under the proposed Standard.

The Bank decided to reject all three of these options. As discussed above, the Bank's approach to interchange fees is not one in which interchange fees are set to recover costs on one side of the system. Rather, the Bank is concerned with the overall effect on the efficiency of the payments system of the configuration of interchange fees across the various individual systems. Although these options were all based on the concept of removing apparent inconsistencies, they would result in changes to the Standard that would have the effect of increasing the cap on interchange fees in the Visa Debit system. This would widen the difference in interchange fees between Visa Debit and EFTPOS, the consequences of which have been discussed extensively above.

As noted in Section 8, in reaching this decision the Bank took into account the possibility that there may be some substitution away from the use of scheme debit cards and towards credit cards. It also took account of the argument that the proposals would cause a deterioration in the competitive position of smaller financial institutions.

Given the above considerations, the Bank has made no material changes to the Visa Debit interchange Standard although it has made a number of changes to the processes required. These are now better aligned with those required under the revised credit card interchange Standard published in November 2005. The main changes are to clarify : the dates on which the weighted average of interchange fees must be no higher than the benchmark; how the weighted average is to be calculated; the requirement to provide information; and a number of definitions. These changes reflect submissions made throughout the consultation process.

To clarify the Standard, the Bank has introduced a new paragraph (paragraph 11) similar to one in the credit card interchange Standard. This paragraph specifies the dates on which the weighted average interchange fee must not exceed the benchmark, namely on 1 November of the year the benchmark is calculated, and on the date any interchange fee is introduced, varied or removed. This means that, as for credit card interchange fees, the weighted average does not need to be below the benchmark at every point in time; it only needs to conform at the points in time set out in paragraph 11. Paragraph 10 (previously paragraph 9) has been amended to refer to these dates. In response to comments that it was unclear how the weighted average of interchange fees is to be calculated, a clarifying paragraph has also been added (paragraph 12).

Some submissions also commented that the calculation of the benchmark requires information that the Bank does not have; namely the average value of a Visa Debit transaction in Australia. The Bank has therefore added paragraph 9 to require the administrator of the Visa Debit scheme to provide the Reserve Bank with data on the value and number of Visa Debit transactions in Australia for the relevant year. Visa has commented that it will need some time to comply with this data request and, in any case, it only has access to data on the number and value of Visa Debit transactions that are exchanged between financial institutions (that is, it does not have data on on-us transactions). To ensure that the appropriate calculation can be conducted, the Bank has also amended the Standard to include a provision that allows the average value of a Visa Debit transaction processed through the Visa system to be used in the relevant calculation where the average value of Visa Debit transactions, based on all transactions, is not available.

In addition to these changes, the Bank has made a number of changes to clarify definitions and align dates with those in the credit card interchange Standard. The definitions of acquirer and issuer have been amended to clarify that these are participants in Australia. In line with the credit card interchange Standard, the definition of a Visa Debit transaction has also been altered to make it clear that transactions are net of credits, reversals and chargebacks. As in the case of the EFTPOS interchange Standard and Access Regime, the definition of a Visa Debit card has been changed to refer to a deposit account held at an authorised deposit-taking institution rather than at the participant that issued the card.

Finally, the date by which the administrator must certify compliance with the Standard has been changed from 30 September to 30 November each year. This addresses Visa's argument that, for administrative ease and convenience, the compliance reporting schedule should align with that for the credit card interchange Standard.

One aspect of the drafting raised by Visa that the Bank has not changed is the absence of a provision for recalculation of the benchmark within the three-year cycle embedded in the Standard. The credit card interchange Standard allows for recalculation within three years if the Bank agrees. Visa asked if the same provision is to be allowed in the Visa Debit case. The Bank considered this issue but decided that it would introduce too many complications into the methodology and the Standard. It therefore decided not to alter the drafting to address this issue.

There are a number of other issues raised by Visa that the Bank has decided do not require drafting changes. These are:

• Visa noted that, as drafted, the Standard does not cover pre-paid cards. This is the Bank's intention and no drafting changes are necessary.
• Visa has asked whether data used to calculate the benchmark for the Visa Debit system will be required to be published. In the Bank's view, it is clear that this is not required.
• Visa noted that publication of the benchmark is required in the Visa Debit interchange Standard. In the credit card interchange Standard released in August 2002, the benchmark was not required to be published and Visa argued the same should apply in this case. Under the amended Standard for credit card interchange fees released in November 2005, however, the benchmark is published. The Visa Debit interchange Standard is thus consistent with the credit card interchange Standard released in November 2005.

The Visa Debit interchange Standard is set out on pages 41 to 43.

Honour all cards Standard

Submissions also suggested that the Bank consider some changes to the honour all cards Standard. In particular, a number of submissions noted the potentially high costs of complying with the Standard.

One option considered by the Bank was to introduce transition provisions to allow more time for issuers to meet the requirement that Visa Debit cards be visually distinguishable. Doing so would mean that costs of replacement will not be brought forward and the fraud risks of having two cards with valid expiry dates in circulation would be avoided. On the other hand, merchants would not be able to visually identify all Visa Debit cards until after the transition period has been completed, and this might reduce some of the benefits of having the honour all cards rule abolished.

On balance the Bank has decided to introduce a transition provision, given the evidence that the potential costs of a rapid transition could be quite high, and that Visa Debit cards will be electronically distinguishable from an earlier date. The Standard will now come into force on 1 January 2007 rather than 1 July 2006 as previously proposed. In addition, the Standard now requires that only cards issued after 1 January 2007 be visually identified as debit cards and sets a final date of 31 December 2009 by which all Visa Debit cards on issue must be visually identified. This three-year period is in line with the card replacement cycles of most institutions offering Visa Debit cards. While cards that can be used in the Visa Debit system must be clearly identified, this is not meant to preclude these cards from also being used for other purposes.

A second option considered by the Bank was to clarify what is required for Visa Debit cards to be distinguished electronically. A number of submissions noted that the requirement in the draft Standard was unclear and, depending upon how it was interpreted, could involve significant costs for the industry in changing systems. Given these submissions, the Bank has decided to make this requirement clearer. The Standard requires that separate Bank Identification Numbers (BINs) for Visa Debit cards be in place by 1 January 2007 so as to allow electronic identification of Visa Debit transactions from the time the Standard comes into force. Visa has indicated that this requirement can be met. Paragraph 11 requires that acquirers provide merchants with information on BINs for Visa Debit cards issued in Australia on request. The Standard places no further obligations on institutions that provide acquiring services to merchants. Merchants will be free to negotiate with their acquirer the development of arrangements that would allow them to electronically decline cards that they are not willing to accept.

In the Bank's view these arrangements meet the right balance of giving merchants the technical ability to select which cards they wish to accept, while not imposing unnecessary costs on the industry.

Visa also noted that unlike the credit card Standard, there was no requirement for acquirers to inform merchants of their new rights under the Standard. A new clause (11(d)) has been added to impose such a requirement. Considerable time has been given for acquirers to meet this requirement.

Finally, some small amendments were made to the definitions of acquirer, issuer, Visa Debit card and Visa Debit card transaction. These changes align with those that were made in the definitions in the Visa Debit interchange Standard.

The honour all cards Standard is set out on pages 44 to 46.

10.2 Implementation schedule

The reforms will be implemented in three steps.

The EFTPOS interchange Standard is being gazetted immediately and comes into force on 1 July 2006.

The EFTPOS Access Regime, as set out in this document, will not be gazetted until the Access Code has been adopted by the industry. This is expected to occur before the end of May. Once the Code has been adopted, the Access Regime will be gazetted, to come into force from the date of gazettal.

The Visa Debit interchange Standard and the honour all cards Standard will not be gazetted immediately. This reflects the view put by Visa that the proposed regulatory treatment of Visa Debit could put it at a competitive disadvantage with respect to MasterCard debit.

As noted in the Bank's Media Release of 20 December 2005, MasterCard has indicated that it will voluntarily conform with standards dealing with interchange fees and the honour all cards rule should such standards be imposed upon the Visa Debit system. Visa has argued that such an approach is not ‘competitively neutral', and that MasterCard has the option of voluntary compliance simply by virtue of the fact that its debit card was introduced only recently in Australia. While the Bank's view is that the effect on the competitive landscape of the different potential treatments is minimal, it can see some merit in the position put by Visa.

Accordingly, the Bank will give both schemes the opportunity to comply voluntarily with the Standards. To facilitate voluntary compliance with the interchange Standard, the Bank would calculate a benchmark, along the lines of paragraph 14 of the Visa Debit interchange Standard, which it would publish. The schemes could then provide the Bank with a legally enforceable undertaking that the weighted average of interchange fees for their debit products would not exceed this benchmark.

The Visa Debit interchange Standard and the honour all cards Standard will only be imposed if, by 1 July 2006, Visa has not provided the Bank with a legally enforceable undertaking that would deliver the same outcomes as would these Standards. Similarly, if, by 1 July 2006, MasterCard has not provided an undertaking with the same effect, the Bank will consider designating the MasterCard debit system. If the MasterCard debit system were designated, the Bank would then consider imposing the same standards as proposed for Visa Debit.

10.3 Review

The Bank has previously committed to commencing a review of the regulation of the credit card schemes towards the end of 2007. That review will now also encompass arrangements in the debit card systems.

Footnotes

See the submission to the Bank by FDI, 17 February 2006. [1]

See submission to the Regulation Review Taskforce by the ABA, 16 December 2005, p26. [2]

Around 15 per cent of EFTPOS transactions involve a component of cash out, and a further one per cent of transactions only provide cash out. [3]