Reform of Australia's Payments System: Issues for the 2007/08 Review – May 2007 VI. Issues

103. The Bank is seeking views from interested parties on the key issues set out in paragraph 9 above, namely:
     1. what have been the effects of the reforms to date?
     2. what is the case for ongoing regulation of interchange fees, access arrangements and scheme rules, and what are the practical alternatives to the current regulatory approach? and
     3. if the current regulatory approach is retained, what changes, if any, should be made to standards and access regimes?
104. This Section sets out these questions in more detail and raises a number of specific issues on which interested parties might wish to provide evidence, analysis and comment.

Q1:What have been the effects of the reforms to date?

105. The Bank is seeking views on the effect of the reforms. It is particularly interested in evidence-based assessments of how the reforms have affected the overall efficiency of the Australian payments system. As discussed above, the reforms have sought to improve efficiency and competition by:
     1. more closely aligning the relative prices for different payment services with the relative costs of providing those services;
     2. addressing restrictions on merchant behaviour that limit competition;
     3. liberalising access to payment systems; and
     4. improving the transparency of the payments system.
106. Interested parties may wish to address the effect of the reforms on consumers, merchants, financial institutions, providers of payment services and payment schemes, as well as the system as a whole. In particular, interested parties may wish to address the following issues.

The effect of the interchange fee reforms on cardholders and merchants

107. Submissions on this issue could usefully provide information on:
     1. the extent to which the pricing of credit cards (including annual fees, interest rates and reward programs) to cardholders has changed as a result of the reforms, and the effect of any changes on cardholder behaviour;
     2. the extent to which the pricing of transaction accounts and per transaction charges for EFTPOS and scheme debit have changed as a result of the reforms, and the effect of any changes on the use of debit cards;
     3. the effect of the changes to interchange fees on merchants’ costs of accepting credit and debit cards, and consequently, on the prices charged by merchants for goods and services;
     4. the extent to which changes in interchange fees have affected the payment methods accepted by various merchants; and
     5. the effect of excluding EFTPOS transactions involving a cash-out component from the EFTPOS interchange Standard.

The effect of the interchange fee reforms on financial institutions

108. Submissions on this issue might address:
     1. the effect of the reforms on the net revenue of financial institutions. (In many analyses of interchange fees it is assumed that these fees are a way of redistributing revenue from acquiring banks to issuing banks in a way that affects the prices facing cardholders and merchants, but not necessarily the net revenue of banks.);
     2. the extent to which the reforms have affected the type of payment methods promoted by financial institutions;
     3. the effect of the reforms on product innovation; and
     4. the compliance costs associated with the reforms.

The effect of the removal of the no-surcharge rule

109. Submissions on this issue could provide information on:
     1. the extent of surcharging, the size of any surcharges relative to merchant service fees, and the extent to which merchants set different surcharges for different payment methods;
     2. the extent to which the ability to surcharge has led merchants who previously did not accept credit cards to now accept these cards; and
     3. the effect of surcharging on cardholder behaviour.

The effect of the modification of the honour-all-cards rule

110. Submissions on this issue could address:
     1. the extent to which the modification of the honour-all-cards rule has led merchants to decline acceptance of scheme debit (or credit) cards, and the effect of the modification of the rule on negotiations over merchant service fees or the setting of interchange fees;
     2. the effect on merchants of the expansion in the number of interchange categories, in particular the introduction of the premium interchange fee under the umbrella of the honour-all-cards rule; and
     3. any effects on product development.

The effect of the reforms on the competitive position of different payment systems

111. Submissions on this issue might offer evidence and analysis on:
     1. the extent to which the reforms have affected the competitive positions of MasterCard and Visa, relative to American Express and Diners Club;
     2. the extent to which the specific details of the interchange Standards have affected the competitive positions of MasterCard and Visa against one another;
     3. the extent to which the competitive positions of EFTPOS and scheme debit have been affected by the reforms; and
     4. any effects of the reforms on product innovation.

The effect of changes to access arrangements

112. Submissions on this issue might wish to address:
     1. the extent of competition between acquirers and whether this has changed as a result of the reforms; and
     2. any remaining obstacles to access.

Q2:What is the case for ongoing regulation of interchange fees, access arrangements and scheme rules, and what are the practical alternatives to the current regulatory approach?

113. Looking forward, the Bank is seeking input on the public policy case for ongoing regulation of interchange fees, access arrangements and scheme rules. It is also seeking views on possible alternatives to the current regulatory framework. The Bank is particularly interested in views regarding payments system regulation that are based on new evidence and analysis and the experience of recent years.
114. As discussed above, a primary consideration in the Bank's decision to regulate credit card interchange fees in 2002 was the judgement that the then current configuration of fees and restrictions on merchants had created a set of price signals to cardholders that were not promoting the overall efficiency of the payments system. In addition, restrictions on access were judged to be limiting competition and were tighter than necessary to preserve the integrity of the payments system. In both these areas, the Bank explored voluntary changes and only opted for regulation once it was clear that such changes were unlikely.
115. In making submissions on the arguments for ongoing regulation and possible alternative approaches, interested parties may wish to comment on the following issues.

What are the characteristics of payment systems that have given rise to public policy concerns, particularly over interchange fees?

116. Submissions on this issue may wish to comment on any lessons from recent experience and insights from theoretical research about the influence of the market structure, conduct and performance of payment systems for the efficiency of the payments system as a whole.
117. As discussed in Section III, the Bank's rationale for regulating interchange fees has rested heavily on the ideas that these fees are not subject to the normal forces of competition and that the then configuration of interchange fees was distorting payment patterns. Submissions may therefore wish to comment on whether, given the current structure of the main payment systems, competition between, and within, these systems is likely to deliver a configuration of interchange fees that promotes the overall efficiency of the payments system. In addressing this issue, submissions might wish to offer evidence on the relative resource costs of different payment methods and the potential for substitution between payment methods.
118. Submissions might also address potential public policy concerns regarding access arrangements and scheme rules in payment systems.

The conditions under which current regulations could be removed or relaxed

119. Submissions on this issue might outline the conditions under which one might have reasonable confidence that the normal forces of competition would deliver a payments system that is competitive, efficient and innovative.
120. Submissions might also assess, based on evidence, whether there have been sufficient changes in market structure or conditions since the reforms were introduced to allow a relaxation or removal of some, or all, of the regulations (see, for example, the discussion of surcharging in paragraph 122). Submissions might also discuss future changes that would allow a relaxation or removal of the regulations. The Bank is also seeking views on alternatives to the current regulations that might address any public policy concerns.

The extent to which the Bank's public policy concerns could be addressed through self-regulation

121. As discussed above, the Bank has always been keen to explore voluntary solutions wherever possible. Submissions on this issue may therefore wish to comment on whether and why self-regulatory solutions are now feasible in a number of areas where, to date, regulation has been required. Submissions may wish to address any roadblocks to self-regulation and the nature of possible self-regulatory solutions.

The extent to which the no-surcharge rule alone could address the Bank's concerns over interchange fees

122. As discussed above, when the regulation of credit card interchange fees was introduced, the Bank considered the case for leaving interchange fees to be set by the schemes and just removing the no-surcharge rule. At the time, it rejected this option, largely on the grounds that surcharging was unlikely to become sufficiently pervasive quickly enough to establish more appropriate price signals in a timely fashion. Submissions on this issue might therefore wish to outline under what conditions surcharging could be considered sufficiently widespread to allow interchange fees to be set by the card schemes, rather than through regulation. Submissions might also address what would be the likely effect of removing interchange regulation, while leaving the no-surcharge rule in place.
123. In addressing these issues, submissions might also consider whether further modifications to the honour-all-cards rule, to allow merchants to make independent acceptance decisions about a broader range of cards, would strengthen any case for removing the regulation of interchange fees (also see paragraph 134).

The extent to which the structure and rules of payment schemes affect competition by limiting the ability of merchants to influence which payment method is used

124. Through the reform process the Bank has sought to remove restrictions on merchants that had the potential to reduce competition or lessen the efficiency of the payments system. Submissions on this issue might address whether there remain restrictions, or other structural constraints, on merchants that weaken competition.
125. Submissions might wish to consider the honour-all-cards rule and the merits of a potential model in which merchants were able to choose how to send a credit card transaction to the issuer. One option would be to allow merchants to send credit card transactions directly to the issuer of a card, rather than using the scheme to direct the transaction. Submissions might wish to assess the feasibility and desirability of this and other alternative options. They might also address whether providing merchants with greater control over how payments are processed would strengthen any case for removing the regulation of interchange fees.

The regulation of other payment systems, including American Express, Diners Club and BPAY

126. As discussed above, the Bank has not formally regulated American Express and Diners Club, or the BPAY system. The Bank is seeking views on whether these schemes should be formally regulated. Submissions on this issue could usefully outline any public policy case for regulation of these schemes and consider what aspects of the schemes’ activities might be subject to regulation and how they should be regulated.

The effectiveness of existing access arrangements

127. The Bank has introduced access regimes for a number of Australia's payment systems. In the case of the EFTPOS system, the regime was introduced to complement an industry-developed access code. The Bank is seeking evidence-based assessments of whether these reforms have achieved their objective of making access to Australia's payment systems more generally practicable. The Bank would also value comment on the extent to which the reforms have made the market more contestable even if there has been limited entry. In the event that shortcomings in access arrangements are identified, views are sought on improvements that could be implemented.

Q3: If the current regulatory approach is retained, what changes, if any, should be made to standards and access regimes?

128. The Bank is seeking views on a number of possible changes to the existing standards and access regimes. For the most part, these possible changes have been raised by various parties over the past few years. They include the following.

A further reduction in credit card interchange fees and/or the adoption of a uniform approach to the setting of all regulated interchange fees

129. When the Bank initially introduced the reforms to the credit card system, it indicated that the reduction in interchange fees from an average of around 0.95 per cent to around 0.55 per cent was the first step towards establishing lower fees. The Bank is interested in views as to whether it is appropriate for credit card interchange fees now to be lowered further. Submissions on this issue might offer analysis of the appropriate level of interchange fees in the credit card system (see also paragraph 131).
130. A related issue is whether the various interchange Standards should be based on a common methodology, perhaps using the same set of cost categories. The current credit card Standard is based on the costs of issuers, while the EFTPOS Standard is based on the costs of acquirers. This outcome largely reflects the Bank's desire to pursue an evolutionary rather than revolutionary reform, and the fact that interchange fees in these two systems were historically very different, flowing in the opposite direction to one another. The Bank is interested in views as to whether a uniform approach to the setting of regulated interchange fees should now be adopted. Submissions on this issue might address how any uniform approach should be established and the consequence of establishing such an approach.

Setting all interchange fees to zero

131. One uniform approach would be to set all interchange fees to zero. Accordingly, the Bank is seeking views on the merits of this approach, including views on the range of payment systems for which zero interchange fees might be appropriate. Submissions on this issue might wish to outline what the case is for ongoing interchange fees as payment systems mature and use and acceptance becomes widespread.

Modification of the compliance aspects of the interchange standards

132. Recently, some industry participants have commented that the way in which the credit card interchange Standard works can provide a competitive advantage to one regulated scheme over another. In particular, it has been argued that the use of backward-looking, scheme-specific weights in the compliance calculations can distort the competitive landscape. As an example, some participants have pointed to the difficulties the Standard may create for a scheme with a relatively high (and possibly increasing) share of premium cards, which now attract relatively high interchange fees.
133. The Bank considered this issue at the beginning of 2007 after consulting with interested parties. It was decided, however, that no action would be taken at that time and the issue would be reconsidered as part of this review. Accordingly, the Bank is seeking views on the merits of a number of possible changes to the operation of the existing interchange standards for the credit and scheme debit systems. These include, but are not limited to: (i) more frequent compliance (perhaps yearly, rather than three-yearly as is the case currently); (ii) the use of industry-based, rather than scheme-specific weights; and (iii) requiring all interchange fees to be below the benchmark.

Modifications to the honour-all-cards rule to include premium and/or pre-paid cards

134. As has been discussed above, over the past five years, there has been an increase in the range of credit cards offered by the credit card schemes, with relatively high interchange fees now applying to corporate and premium cards. Under the schemes’ honour-all-cards rules, a merchant must accept all types of credit cards issued by a scheme if it wants to accept any credit cards. The Bank is interested in views as to whether the honour-all-cards Standard should be modified to allow merchants to accept some, but not all types of credit cards. Submissions are therefore sought on the possible scope of the honour-all-cards rule and how any modifications to the Standard would work in practice. One modification, for example, might allow merchants to accept standard cards but to decline acceptance of premium cards if they judged that the merchant service fees applying to these cards were too high. Another possible modification would be to allow a merchant to decline acceptance of a scheme's pre-paid cards, while accepting its debit cards.

The regulation of interchange fees on EFTPOS cash-out transactions

135. At the time the Bank introduced its final Standard on EFTPOS interchange fees it elected not to regulate interchange fees on EFTPOS transactions with a cash-out component. The Bank welcomes views on whether it would be appropriate to treat all EFTPOS transactions uniformly, or otherwise regulate EFTPOS transactions with a cash-out component. Submissions might also wish to address whether interchange fees for EFTPOS cash-out transactions and ATM transactions should be treated in an equivalent manner.

Possible changes to legislation to allow the RBA to set interchange fees directly

136. The regulation of interchange fees has been by way of setting a standard under the Payment Systems (Regulation) Act 1998. The legal requirements for setting a standard have complicated the setting of interchange fees, and led to lengthy debates about what costs should and should not be included in the standard. It has also led to the industry having to undertake periodic cost studies to conform to the standard. Over recent years, some participants have suggested that the regulatory process would be more straightforward, and involve fewer costs, if the Bank were able to set interchange fees or an interchange benchmark directly. The Bank is therefore seeking views on the merits of a change to the legislation that would allow such an approach.

The availability of information on Australian payment systems

137. An important aspect of the Bank's reforms has been to improve the transparency of the Australian payments system. The Bank is seeking views on whether there is a need for additional information to be available to market participants, and how best any additional information should be supplied.