Reform of Australia's Payments System 6. The Board's Response

Following this latest round of consultation, the Board remains of the view that the reforms have met their key objectives. They have: increased transparency; improved competition by removing restrictions on merchants and liberalising access; and promoted more appropriate price signals to consumers. Nevertheless, as discussed in Section 3, the Board remains of the view that the competitive forces acting on interchange fees are still relatively weak. The Board has therefore concluded that there are aspects of the payments system that will continue to require close oversight.

The Board acknowledges that precise quantitative measurement of the aggregate welfare gains from the reforms faces a number of challenges, particularly given the inevitable uncertainties about what would have happened in the absence of the reforms. Notwithstanding this, the Board remains of the view that based on reasonable assumptions, the welfare gains have been significant. In reaching this conclusion, the Board recognises that the effect of the reforms has not been evenly spread.

One argument that was raised through the consultation process to which the Board has paid particular attention is that the reforms have slowed the pace of innovation in the Australian payments system. While it is clear that the reforms have been a primary focus of many industry participants over recent years, the Board is not persuaded that innovation has been harmed by the regulatory process. Instead its assessment is that the relatively slow pace of innovation over recent years largely reflects governance and co-ordination issues in some of Australia's payment systems, rather than the regulatory environment. Notwithstanding this, over the longer term, innovation is more likely to occur in a regime under which the regulatory arrangements are relatively stable and industry participants can make long-term plans.

Similarly, the Board is not persuaded that in the absence of some form of regulatory oversight the competitive forces would be strong enough to ensure that interchange fees will be set at levels that promote the overall efficiency of the system. This is particularly so if the schemes were to attempt to reimpose their various restrictions on merchants. While, in principle, the competitive dynamics could be changed by merchants co-ordinating their acceptance decisions or choosing which payment system is used to process credit card payments, neither of these changes appears to be practical at the current time.

Although the Board is of the view that oversight of card payment systems remains necessary, this does not necessarily imply a need for explicit regulation. Indeed, the Board would be prepared to remove the current regulations if the various payment systems took sufficient steps to address the various issues identified by the Board over recent years. However, in the absence of the schemes voluntarily changing their rules and procedures to remove restrictive rules and enhance transparency, some form of ongoing regulation is likely to be required. Notwithstanding this assessment, the consultation process has confirmed the Board's view that, given the changes that have taken place over recent years, there is now an opportunity for it to step back from regulation of interchange fees, provided that further steps are taken by industry participants.

6.1 The preferred approach

Given the improvement in the competitive environment over recent years, the Board is prepared to deregulate interchange fees. The Board remains concerned, however, that if it were to deregulate unconditionally, interchange fees (particularly in the credit card systems) would rise from their current levels, perhaps substantially. Given this concern, the Board has concluded that it will only step back from the regulation of interchange fees if industry participants take steps to reduce the risk of this outcome.

In the Preliminary Conclusions, the Board indicated that one way in which this could be achieved is for industry participants to further strengthen the competitive environment including through: changes to the EFTPOS system to improve its ability to compete effectively with the international card schemes; further modifications to honour-all-cards rules to allow merchants to make separate acceptance decisions for any card for which there is a separate interchange fee; and an improvement in the transparency of scheme fees and average interchange fees. The Board also indicated that if interchange fees in the credit card systems were to rise materially following deregulation, it would consider the reimposition of regulation on these fees.

Through the consultation process, a number of parties expressed concerns about some elements of this approach, particularly relating to honour-all-cards rules, and the uncertainty around the regulatory response if interchange fees were to rise after deregulation. The Board recognises these concerns and is prepared to consider other ways of helping ensure that interchange fees do not increase from current levels. How this might be done is discussed below.

As part of its deliberation, the Board has also given further consideration to a number of issues raised in consultation. In particular, it has considered industry views on: proposals to further modify honour-all-cards rules; what might be required of an EFTPOS scheme; capping of surcharges; and transparency. It has also reconsidered the levels of the benchmarks on interchange fees if regulation were to continue.

6.1.1 Further modifications to honour-all-cards rules

As noted in Section 5, a number of submissions argued that further modifications to honour-all-cards rules would be detrimental to the payments system. The Board, however, remains unconvinced that such modifications would result in either substantial consumer confusion or brand damage. Indeed, if the competitive process is working well, merchants are unlikely to decline acceptance because the schemes will have an incentive to set interchange fees at a level that encourages acceptance. The experience with scheme debit, where there have been no cases of which the Board is aware of merchants accepting credit cards but refusing to accept scheme debit, provides a basis for this conclusion.

On the other hand, the Board accepts that visual identification of different cards is difficult and, therefore, potentially costly system changes would be required by acquirers to give effect to these modifications. It also accepts that differential surcharging by merchants could generate a similar result to modifying the honour-all-cards rules. In addition, evidence from acquirers suggests that most merchants are not charged a separate merchant service fee for different types of cards. This practice limits the potential benefits of further modifying the honour-all-cards rules.

The arguments here are finely balanced. However, the Board is of the view that if it proceeds with deregulation of interchange fees – and is relying on competitive forces to help ensure that interchange fees do not rise – it needs to provide merchants with all possible negotiating tools to ensure maximum competitive pressure on these fees. Further modifications to honour-all-cards rules would assist in this process. The Board does not, however, envisage mandating across-the-board changes to systems or to cards to achieve this. Rather, it expects that acquirers will respond to requests from merchants to facilitate non-acceptance. The Board would, however, monitor developments in this area and consider requiring such changes if there was a case to do so.

These considerations have not altered the Board's conclusion on the acceptance of pre-paid cards. It remains of the view that merchants should not be required to accept a scheme's pre-paid card or debit card as a condition of accepting the scheme's credit card. The Board encourages the schemes to allow separate acceptance decisions for pre-paid cards and, in the event that they do not do so, the Board would consider regulation. Furthermore, the Board considers that MasterCard's current practice of charging higher interchange fees to a merchant that does not accept all cards is not in the spirit of the reforms. Although not expressly prohibiting merchants from declining acceptance of pre-paid cards, it has the effect of discriminating against merchants that choose to do so. The Board is of the view that this practice should be removed, and if it is not the Board would consider requiring changes through regulation.

6.1.2 The EFTPOS scheme

Through the consultation process a number of industry participants sought greater clarity regarding how the Board might assess whether developments in the EFTPOS system were adequate to meet the requirement of a viable competitor to the international schemes.

The Board is reluctant to be too prescriptive here. In its Preliminary Conclusions, it noted a number of developments that would provide it with some comfort that the competitive environment was being strengthened. These included:

• the introduction of a scheme to replace the existing bilateral contracts, with the scheme able to make decisions about multilateral interchange fees;
• the creation of effective arrangements to promote the development of the scheme;
• reform of current access arrangements; and
• the development of alternative payment instruments for use in online payments (either by the EFTPOS scheme or some other channel).

At a very general level, when making its assessment the Board will be looking at whether a scheme has been established, has an effective governance structure and is actively considering promotion and business development. The specific suggestions were not meant to imply that without these developments, the Board would be unable to step back. Rather, they were provided as examples of developments that would weigh in the Board's assessment of whether the EFTPOS system was likely to provide meaningful competition over the medium term.

One issue that was raised in submissions was whether the governance structure of the scheme will ensure the EFTPOS scheme can make decisions and take actions that are in its own interests rather than, for example, only those of the largest issuers of EFTPOS cards. A number of parties noted in consultation that the outcome from an EFTPOS scheme could be highly dependent on its governance structure and, in particular, whether decision making is dominated by the largest banks. An outcome where the interests of one or two large banks could prevent the scheme from taking action judged to be in the interests of the scheme as a whole would be unlikely to meet the Board's expectations. The Board will look closely at the governance structure to assess whether there are appropriate checks and balances in the decision‑making processes.

A second aspect that the Board will consider in its assessment is the role of multi-function cards in facilitating competition between the debit card systems. The prevalence of these cards, combined with the modifications to honour-all-cards rules, facilitate network choice by merchants for debit card payments. In particular, a merchant is able to steer a customer towards its preferred payment option on a multi-function card – or even decline its non-preferred option – with limited risk of losing the sale. If financial institutions were to move away from issuing multi-function cards in any substantial way this could lessen competition between the schemes and the EFTPOS system.

A number of participants also sought guidance on the Board's expectations with regard to an online payment system. In the Preliminary Conclusions, the Board indicated that the development of alternative payment instruments for use in online payments would strengthen the case for deregulation of interchange fees. It noted, however, that this need not be through EFTPOS – it could be developed through another channel. Indeed, a number of submissions suggested that alternatives from outside the EFTPOS system might soon be available.

In the time since the release of the Preliminary Conclusions, there has been less progress in the development of an alternative online payment system than the Board had previously expected. Apart from the concerns this raises about the ability of the industry to promote innovation in the Australian payments system, it introduces some doubt as to the speed of progress in this area. The Board continues to see it as important that consumers have a range of options available when making online payments.

Finally, a number of submissions suggested that a multilateral interchange fee may not be necessary for the EFTPOS system to be a viable competitor and that its interests may be best served by the maintenance of the current system of bilateral interchange fees. In the Preliminary Conclusions, the Board saw reasons why the ability to set a multilateral fee might be important for an EFTPOS scheme to promote its use. The consultation process has, however, suggested that this need not necessarily be the case. In particular, it has been suggested that the current system of bilateral interchange fees combined with the ability of merchants to decline acceptance of scheme debit cards makes it more likely that the EFTPOS system will be promoted and supported by merchants. Given these contrasting arguments, the Board has no particular view either way on which interchange fee regime might be best for the EFTPOS system; this matter is best left to the scheme to determine.

6.1.3 Capping of surcharges

The Board has not changed its view that there have been substantial benefits from the removal of no-surcharge rules. The share of merchants surcharging is continuing to increase and this is improving the competitive dynamics and price signals in the payments system. Evidence from card schemes and merchants indicates that the ability to surcharge is putting some downward pressure on interchange fees and merchant service fees in some areas.

In response to submissions, the Board has again considered the issue of caps on surcharges. On balance, it remains of the view that the case for such caps is relatively weak. The main arguments in favour of capping surcharging relate to improved consumer experience and limiting brand damage to the schemes from surcharges that are much higher than the relevant cost to the merchant. The Board, however, does not see the isolated cases of high surcharges as sufficient grounds to allow the schemes to reimpose restrictions on all merchants and hence limit their negotiating flexibility. Indeed, survey data suggest that, on average, surcharges are very similar to average merchant service fees, although there are some cases where surcharges appear considerably higher than these fees. This latter outcome is likely to reflect the market power of the merchants concerned which, if surcharging were capped, would likely find its way into higher prices in some other way. Finally, as noted above in its conclusion on honour-all-cards rules, the Board is of the view that in order to step back from interchange regulation, as much competitive pressure should be brought to bear on interchange fees as possible. Permitting a cap on surcharges would, at the margin, reduce such pressure.

Another issue considered in relation to surcharging was the role of no-surcharge rules in ‘new’ payment systems. The Board recognises that a no-surcharge rule might, in some limited circumstances, potentially be useful to a new payment system during its development phase when achieving critical mass of acceptance and use is important. It is, therefore, of the view that it would be inappropriate to rule out such a possibility categorically. Rather, the issue would need to be examined on a case-by-case basis.

Finally, the Board has considered the issue of disclosure of surcharges. Its strong view remains that any surcharge for the use of credit cards should be clearly disclosed to the customer prior to commencement of the payment process; in fact, in order for disclosure to be meaningful, this may require some merchants to disclose the surcharge even before the customer selects their purchase. Furthermore, a merchant should not mislead customers about the surcharge, for example, by claiming it is recovering the merchant fee when in fact the surcharge is substantially higher than the merchant fee. The Australian Securities and Investments Commission has produced a guide on Merchant Pricing for Credit Card Payments which sets out the disclosure requirements for merchants that choose to surcharge.^[1]

6.1.4 Transparency of scheme fees

While the schemes have expressed some concerns about commercial confidentiality associated with the publication of scheme fees, most other submissions were in favour of increased disclosure. In the same way that interchange fees, which are now published, affect merchant service fees, so too do scheme fees. But, in contrast to interchange fees, the level of scheme fees is not disclosed. In addition to better informing merchant negotiations, improved transparency would assist in monitoring any changes in the structure of scheme fees which might be associated with new means of transferring revenue from acquirers to issuers. This improved transparency would be important regardless of whether or not the Bank were regulating interchange fees. The Board, therefore, remains of the view that information on the level of scheme fees should be available to merchants. The Bank will work with the schemes to address legitimate confidentiality concerns while ensuring that meaningful disclosure takes place.

The Preliminary Conclusions also noted that the fees and procedures that apply if an acquirer wishes to bypass scheme switches should also be transparent. The Board notes that there have recently been some improvements in transparency of scheme rules and the Bank will be discussing with industry participants whether further improvement is necessary.

6.1.5 An alternative way of meeting the Board's concerns

As noted above, some industry participants have expressed concerns regarding the ongoing regulatory uncertainty associated with the Board's preferred course of action. Concerns have also been expressed about the degree to which progress in establishing improved EFTPOS arrangements and alternative methods for online payments would affect the regulatory outcome for the credit card schemes. One possibility that was raised during consultation is that this uncertainty could be removed if the credit card schemes provided a public commitment that average interchange fees in the credit card systems would not be increased from current levels.

If the schemes were to provide such a commitment, the case for requiring further modifications to honour-all-cards rules to allow separate acceptance decisions for products that have different interchange fees is weakened. In particular, this type of commitment could provide the comfort that the Board is seeking that credit card interchange fees would not rise from current levels. As a result, the potential benefits of further changes to the honour-all-cards rules are somewhat reduced, making it less likely that these benefits exceed the costs associated with necessary system changes. As such, the Board is of the view that this particular change proposed to the honour-all-cards rules would not be required. The Board would still, however, require that acceptance of pre-paid cards not be bound by honour-all-cards requirements.

If a commitment on the level of credit card interchange fees were to eventuate, the Board would not see a need for similar caps on scheme debit and EFTPOS interchange fees. To impose such caps would, in effect, simply re-establish the status quo with voluntary commitments. Instead, the Board would rely on competitive pressure from the EFTPOS system and, in particular, the ability of merchants to steer transactions through the EFTPOS system if scheme debit interchange fees are too high, to help constrain the level of debit interchange fees.

One issue that has arisen in discussions with industry participants is how some form of commitment might be achieved. One possible approach would draw on the model used for scheme debit interchange in which the Bank published a draft standard and offered the schemes an opportunity to provide an undertaking that they would abide by the standard. In this case, rather than publish a draft standard the Bank would publish a ‘Commitment’ to which the schemes might bilaterally agree. Two examples of such a commitment are provided in Appendix 2. The Bank is prepared to consult with industry participants regarding the exact form of any commitment, although it would need to ensure that the average level of credit card interchange fees was no higher than the current level of around 0.5 per cent.

6.1.6 If the Board's concerns are not addressed

If in August 2009 the Board judges that insufficient progress has been made in addressing its concerns then regulation of interchange fees will continue. If this is the outcome, the Board sees a strong case to further reduce the difference between interchange fees in the various systems.

The Board has not changed its view that if interchange fee regulation is to continue, the benchmark for credit card interchange fees should be reduced to around 0.3 per cent. In response to views expressed in consultation, however, the Board has reconsidered the need to impose the same interchange benchmark on the scheme debit and EFTPOS systems. Under the current set of regulations, a transaction on a scheme debit card attracts, on average, around 17 cents more interchange revenue for an issuer than an equivalent transaction using the EFTPOS system. The Board had been concerned that, were this differential to persist, the EFTPOS system would be at a disadvantage to the scheme debit systems, not because of its merits but because issuers can earn more interchange revenue from a scheme debit transaction than for an EFTPOS transaction. Given this concern, the Board had proposed that the same benchmark – 5 cents paid to the issuer – apply to both debit card systems.

This proposal attracted criticism from merchants who argued that such an outcome would make it more difficult for the EFTPOS system to compete effectively with scheme debit. Currently, with interchange flowing from issuers to acquirers, large merchants in particular have the incentive to promote the use of the EFTPOS system by their customers – in the extreme by refusing to accept payments using scheme debit cards. It was argued that eliminating the differential in interchange fees would result in the merchants having no such incentive and perhaps even result in merchants encouraging customers to use scheme debit. Furthermore, if the exemption for cash-out transactions were removed, as the Board concluded it should be, merchants would have a reduced incentive to offer cash out to customers, instead directing customers to more expensive cash withdrawals at ATMs in their stores. The outcome, according to the merchants, would be a decline in the EFTPOS system and more expensive cash withdrawals for customers.

The merchants' views highlight the issue of how payment systems balance promotion of merchant acceptance and consumer use. The Board has previously come to the conclusion that payment systems often have a tendency to focus more heavily on promoting consumer use. This reflects a number of observations including: the tendency of payment systems to compete by raising interchange fees to attract issuers; the fact that consumers (rather than merchants) make the choice of payment instrument at the time of payment; the prevalence of incentives to consumers to use credit cards; and the argument put to the Bank over many years by merchants that they have very little choice but to accept credit cards because of consumer pressure. In considering an appropriate differential between scheme debit and EFTPOS interchange fees if regulation were to continue, the Board therefore gave weight to the argument that systems with higher interchange fees would have an advantage because they would be promoted by issuers while continuing to be accepted by merchants.

The submissions from the merchants suggest that, rather than constraining interchange fees in the two systems to be the same, any regulatory option should provide some flexibility for the debit card systems to have different interchange fees. Thus, in the event that satisfactory voluntary reform does not eventuate, the Board proposes to change the existing interchange regulations such that:

• the weighted average of interchange fees in each of the scheme debit and EFTPOS systems would be constrained to be between 5 cents paid to the issuer and 5 cents paid to the acquirer; and
• credit card interchange fees would be capped at a weighted average of 0.3 per cent.

While the same regulatory framework would apply to both EFTPOS and scheme debit, there would be flexibility for EFTPOS to maintain fees that flowed to the acquirer and scheme debit to have fees that flowed to the issuer.

Requiring the weighted average for EFTPOS interchange fees to be within a band only makes sense, however, if these fees are set by the scheme as multilateral fees. If bilateral fees are maintained in the EFTPOS system, such an approach poses a number of practical problems – not least of which is how such a weighted average would be calculated. In this case, the Board is of the view that, in order to maintain the same general framework for setting interchange fees in the two systems, the actual bilateral EFTPOS interchange fees would be required to be between 5 cents paid to the issuer and 5 cents paid to the acquirer. The current non-discrimination provisions, which prevent bilateral negotiation over interchange fees from hindering the ability of new entrants to compete in the EFTPOS system, would continue to apply.

Finally, there is the issue of cash-out transactions. When the Board regulated EFTPOS interchange fees in 2006, it exempted cash-out transactions on the basis that interchange fees for a substitute channel for cash, ATMs, were unregulated. Interchange fees in the ATM system are soon to be set at zero and, if scheme debit systems were to introduce cash out (which may be possible now that PINs can be used for scheme transactions), interchange fees on these transactions would not be exempted from regulation. The Board, therefore, does not see a strong case for maintaining this exemption for EFTPOS cash-out transactions if interchange fees continue to be regulated. The flexibility of the weighted-average calculation in this option, however, still allows for a payment to the merchant for a cash-out transaction if an EFTPOS scheme judges that such a model will best promote its interests. Such flexibility would, of course, be diminished if interchange fees remained bilateral.

6.2 Summary

In summary, the approach being adopted by the Board is the following.

1. The Board is prepared to step back from the regulation of interchange fees provided its concern that interchange fees in the credit card systems might rise in the absence of regulation is addressed.
2. One way in which this could be done was suggested in the Preliminary Conclusions and involves a further strengthening of the competitive environment by industry participants: making changes to the EFTPOS system to improve its ability to compete effectively with the international card schemes; further modifying the honour-all-cards rules to allow merchants to make separate acceptance decisions for any card for which there is a separate interchange fee; and increasing the transparency of scheme fees and average interchange fees. This remains the Board's preferred approach, although it would be prepared to consider the reimposition of regulation if average credit card interchange fees were to rise again.
3. An alternative way of meeting the Board's concerns would be for the schemes to commit to limiting the weighted average of their credit card interchange fees to the current level (0.5 per cent). If this approach were adopted, the benefits from further modifications to the honour-all-cards rules suggested above would be reduced, and accordingly the Board would not see a need for these changes to be made.
4. The Board will assess the degree of progress in meeting its concerns in August 2009. If at that time it judges that insufficient progress has been made, regulation of interchange fees will be retained with the benchmark for credit card interchange fees reduced to 0.3 per cent as proposed in the Preliminary Conclusions. In the EFTPOS and scheme debit systems, a common approach to setting interchange fees is being proposed, although the schemes would have more flexibility than was suggested in the Preliminary Conclusions. In particular, average interchange fees would be constrained to be between 5 cents paid to the issuer and 5 cents paid to the acquirer.
5. In assessing whether the competitive environment has been adequately strengthened, the Board will consider: the governance structure of the EFTPOS system; whether there is an alternative online payment system in prospect (not necessarily provided by the EFTPOS system); and whether multi-function cards continue to be maintained. It may also consider other issues, including whether the schemes have committed to limiting interchange fees.
6. The schemes will not be permitted to reimpose no-surcharge rules. As currently, a merchant will be able to agree with an acquirer to limit its surcharge but neither schemes nor acquirers will be permitted to unilaterally impose a cap on a merchant.
7. The current modification to honour-all-cards rules, allowing separate acceptance decisions for scheme debit and credit cards, will remain. In addition, the Board encourages the schemes to permit merchants to make separate acceptance decisions on pre-paid cards and to alter pricing arrangements that effectively penalise merchants who do not accept all cards. If these changes are not made the Board would consider regulation.
8. Further transparency of scheme fees will be required. The Bank will be working with the schemes to find a mechanism of achieving this while balancing the schemes' concerns that scheme fees are commercially sensitive. Again, if an agreement cannot be reached, the Board would consider regulation.
9. If regulation of interchange fees were to continue, the Board would not require further modifications to honour-all-cards rules to allow separate acceptance decisions for any card with a separate interchange fee, although it would still seek greater transparency of scheme fees.

Footnote

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