Reform of Australia's Payments System Appendix 2: Possible Modifications to Existing Standards

If Options 1 or 2 were adopted, the Board sees a strong case for making a number of changes to the existing Standards to enhance their functioning. These are discussed below.

1. The Frequency of Cost Studies and Benchmark Recalculations

Through the consultation process a number of institutions have argued that there are high compliance costs associated with having to undertake cost studies every three years for the interchange Standards. Estimates of these costs provided to the Bank suggest that complying with the initial benchmark in 2003 cost financial institutions in the order of $1 million.

In the Board's view, the benefit from frequent cost studies is relatively small. As has been discussed elsewhere, the Board does not see interchange as being explicit compensation for particular costs that institutions incur in providing payment services. Rather, the cost studies have been used to establish transparent benchmarks for the setting of interchange fees. Having established these benchmarks, the case for updating the cost studies on a regular basis is not particularly strong, especially given that changes in costs do not necessarily justify changes in interchange fees. By eliminating the need to undertake these cost studies, compliance costs would be reduced and, at the margin, less frequent recalculation of the benchmark might also assist in longer-term planning.

The Board's preferred approach is to simply remove the need for any further cost studies and recalculation of the benchmark. Under this approach, all interchange Standards would be based on the credit card cost studies conducted in 2006. If at some future point, the Board decided to review the level of average interchange fees a new cost study could be undertaken, or the costs included in the Standards could be amended.

2. Compliance Arrangements

One issue that was raised in the consultation process was whether the compliance aspects of the Standards (particularly the credit card interchange fee Standard) were affecting competition between schemes.

The compliance arrangements have been under review for some time, with the Board seeking submissions in December 2006. Of particular interest has been whether the use of backward-looking, scheme-specific weights to calculate each scheme's weighted-average interchange fee meant that a scheme with a relatively high weight in a category with a high interchange fee was disadvantaged. Some industry participants have also expressed a concern that the weighted-average interchange fee was moving above the benchmark between the three-yearly compliance dates.

The compliance arrangements will also need to be reviewed if, as is discussed above, the three-yearly cost studies are no longer undertaken, as the existing Standards only require the schemes to meet the benchmark when the benchmark is recalculated (or when interchange fees are changed).

Three main suggestions for changing the current arrangements have been proposed by industry participants:

1. using industry, rather than scheme-specific, weights in the compliance calculations;
2. requiring all interchange fees (rather than the weighted-average) to be below the benchmark; and
3. more frequent compliance.

Modifying the Standards so that the weights in the compliance calculation are determined using proportions of transactions across the whole industry presents some considerable practical difficulties. In particular, the schemes would somehow need to agree on common categories for the compliance calculations, and the categories would probably need to be included in the Standards. The Board is of the view that this approach introduces considerable complexity to the regulations and increases compliance costs with no increase in efficiency and competition. It therefore is not in favour of such an approach.

Modifying the Standards to require that all interchange fees be below the benchmarks has the advantage of simplicity. However, this change may reduce competition by inhibiting the ability of the four-party card schemes to compete with three-party schemes in the premium and commercial cards markets. It could also lead to all interchange fees being set at the cap to maximise the interchange revenue available to issuers. This would reduce the likelihood of particular incentives, such as for the installation of chip-capable terminals, being created through the interchange fee structure. The Board is therefore not in favour of this approach.

Increasing the frequency of the compliance calculations could help address concerns about competitive neutrality by reducing the incentive for issuers to switch schemes to take advantage of a high interchange fee in a particular category. As the weight of the high-fee category grows, the scheme will have to lower its fee in order to meet the benchmark. But since this would happen on a shorter time frame than currently, it may reduce the benefit that issuers can obtain from exploiting the difference in fees. This approach would also limit the degree to which the average could drift above the benchmark between calculations.

The Board has considered two main possibilities: annual compliance and ‘continuous’ compliance. Annual compliance is administratively more straightforward and would avoid the possibility of schemes ‘accidentally’ being in breach of the Standard because of unanticipated changes in the composition of spending. A number of acquirers have, however, expressed concerns that a move to annual compliance might lead to more frequent changes in interchange fees and thus additional costs to them due to the more frequent need to reprice acquiring services.

The Board's preliminary conclusion is that if interchange regulation remains, compliance should be annual. It would welcome feedback on the costs and benefits of such a change and whether there are other schedules or options that would address concerns over the effect of the compliance arrangements on scheme competition and average interchange fees.

3. Cash-out for EFTPOS

Under the current arrangements, interchange fees on transactions involving a cash-out are excluded from the EFTPOS interchange fee Standard. This reflected a view by the Board that if ATM interchange fees were not regulated, the case for regulating interchange fees on cash-out transactions was not particularly strong. Since that time, however, the ATM industry has agreed to reform involving the removal of interchange fees in ATM networks. Given this development, the exemption for cash-out transactions could beneficially be removed. Doing so would simplify the setting of interchange fees in the EFTPOS system with correspondingly lower costs for industry participants and easier access, and would be unlikely to have any detrimental effect related to relativities with the ATM system.

The Board's preliminary conclusion is, therefore, that if interchange regulation is maintained the exemption for cash-out transactions in the EFTPOS interchange fee Standard be removed.