Reform of Australia's Payments System 3. The Current Regulatory Landscape

3.1 The origin of the reforms

The current regulatory landscape has its origins in the findings of Debit and Credit Card Schemes in Australia: A Study of Interchange Fees and Access (the Joint Study) undertaken by the Bank and the Australian Competition and Consumer Commission (ACCC) and published in October 2000. The Joint Study emphasised both the substitutability of individual payment instruments, and the need for a system-wide approach. It found that credit card interchange fees had contributed to many holders of credit cards facing negative effective prices for credit card transactions, while interchange fees in the EFTPOS system contributed to many people facing positive effective prices for EFTPOS transactions. This higher price for EFTPOS transactions was despite the EFTPOS system having substantially lower operating costs per transaction than the credit card system. The Joint Study also concluded that the case for an interchange fee in debit card systems on the grounds of balancing issuers’ and acquirers’ costs (as advocated by the card schemes) was not strong.

In the years following the publication of the Joint Study, the Board introduced a number of reforms to address the issues identified. Although the Joint Study highlighted the interrelationship between the various card payment systems, these reforms have been sequential, rather than simultaneous. This reflects a variety of factors, including legal considerations and the Board's willingness to allow industry to explore solutions before regulatory solutions are considered.

The first reforms were those to the credit card system. In March 2000, an independent investigation by the ACCC concluded that the collective setting of interchange fees in the credit card schemes was in breach of the price-fixing provisions of the Trade Practices Act 1974. The ACCC advised the credit card schemes and their members that they should seek authorisation of the interchange fee agreements or cease collective setting of these fees. After a year of discussions with the banks, the ACCC concluded that the authorisation process was unlikely to meet its concerns about competition and efficiency and, in March 2001, asked the Bank to consider using its powers to address the issue of interchange fees.

After consultation, the Payments System Board formed the view that it would be in the public interest to bring the credit card schemes under the Bank's regulatory oversight. As a result, in April 2001, the Bankcard, MasterCard and Visa credit card systems were designated under the Payment Systems (Regulation) Act after it became clear that the Board's concerns were unlikely to be addressed voluntarily by the schemes. The Bank then commenced a process of consultation on potential standards and access regimes. These reforms were finalised in August 2002 and came into effect during 2003 and 2004.

After the reforms were finalised, MasterCard and Visa launched legal challenges to the Bank's powers to designate the credit card systems and impose standards and access regimes. The case was heard in 2003 in the Federal Court, with the decision, released in September 2003, finding in favour of the Bank on all grounds.

Reform of the debit card systems followed some time later. Following the Joint Study, the Bank's discussions with industry participants suggested that there was a reasonable probability that interchange fees in the EFTPOS system would be reduced without the need for regulation. Indeed, in February 2003 a group of industry participants agreed to set interchange fees in the EFTPOS system to zero, and sought ACCC authorisation for the proposal. The ACCC eventually approved the proposal, although the approval was subsequently overturned by the Australian Competition Tribunal (ACT) following an appeal by a group of merchants. After the ACT's decision, the Board judged that the prospect for further industry-based reform was limited, and it designated the EFTPOS system in September 2004. This designation was then challenged unsuccessfully in the Federal Court by the same group of merchants that had challenged the earlier industry agreement.

Given the strong potential substitutability between EFTPOS and scheme debit, the Board viewed it as important that changes to these systems occur at the same time. The Board designated the Visa Debit system in February 2004 and, once the industry reform proposal for EFTPOS had failed, proceeded to consider interchange fees in the two systems together.^[1] In February 2005, the Bank released a consultation document, setting out the proposed reforms in the EFTPOS and scheme debit systems. Following consultation, the reforms were finalised in April 2006. The interchange fee Standards and the EFTPOS Access Regime came into effect in 2006, while the honour-all-cards Standard came into effect in January 2007. MasterCard agreed to implement equivalent reforms for its debit card system with voluntary undertakings rather than the Bank imposing standards.

3.2 The reforms

The Board's reforms to the card-based payment systems have been in three broad areas: the removal of various restrictions on merchants imposed by the card schemes; the regulation of interchange fees; and the introduction of more liberal access arrangements. The reforms are summarised in Table 1 and more detail is provided in the sub-sections below.

3.2.1 Merchant restrictions

In its early work, the Board identified a number of restrictions on merchants that were detrimental to efficiency and competition in the payments system. These included rules that:

• prevented merchants from surcharging for credit card and scheme debit card transactions (the no‑surcharge rule);
• required a merchant to accept a scheme's debit card if it accepted its credit card and vice versa (the honour-all-cards rule); and
• prevented merchants from steering customers to other forms of payment (the no‑steering rule).

The Board concluded that the no-surcharge rule masked the price signals to cardholders about relative costs of different payment methods and limited the ability of merchants to put downward pressure on interchange fees by threatening to charge the customer for using a credit card. It also contributed to the subsidisation of credit card users by all other customers, as merchants charged a uniform price to all consumers regardless of the payment method used, with this uniform price needing to cover the relatively high costs of credit card acceptance.

MasterCard and Visa declined to voluntarily remove their no-surcharge rules and, as a result, the Bank imposed standards requiring the removal of these rules from 1 January 2003. American Express and Diners Club voluntarily agreed to remove their equivalent rules.

The honour-all-cards rule in the MasterCard and Visa schemes had two distinct aspects: one relating to honouring all issuers and the other to honouring all products. The Board recognised the merits of the honour all issuers aspect of the rule, but concluded that the honour all products aspect was not in the public interest. It concluded that the tying of credit and debit card acceptance adversely affected competition, particularly between EFTPOS and scheme debit, by forcing merchants to accept a payment method they might not otherwise accept, at a price they might not otherwise pay.

Visa declined to modify voluntarily its honour-all-cards rule and, as a result, the Bank imposed a standard requiring that the rule be modified in the Visa system to allow merchants to make separate acceptance decisions for Visa credit and debit cards from 1 January 2007. In contrast, MasterCard provided a written undertaking to voluntarily comply with this Standard. Similarly, while American Express does not issue a debit product in Australia, it has agreed to voluntarily comply with the Standard if it introduces debit or pre-paid products in the future.

Finally, the no-steering rule prevented merchants that accepted American Express cards from encouraging customers to use another method of payment (equivalent rules did not exist in the Diners Club, MasterCard and Visa schemes). Again, the Board saw this rule as inappropriately restricting competition and, after discussions, American Express agreed to remove the rule.

3.2.2 Interchange fees

When the Board first considered the regulation of the credit card system in 2001, it considered whether just requiring the removal of the no-surcharge rule would be sufficient to establish price signals that better promoted competition and efficiency in the payments system. Although recognising that removing the no‑surcharge rule would be a positive step, the Board was not convinced that surcharging would become sufficiently commonplace within a reasonable time to materially alter the price signals facing most cardholders. A particular concern was that surcharging was likely to develop only slowly given the strong expectation by cardholders that no surcharges would apply – an expectation built up over a number of decades in which the schemes prohibited the practice. The Board therefore came to the conclusion that both the removal of the no‑surcharge rule and a reduction in the difference between interchange fees in the various systems were necessary to establish more appropriate price signals to cardholders.

Reflecting this view, the Board introduced a number of regulations to reduce interchange fees in the card payment systems and move them closer together. These reductions were achieved by the imposition of standards which capped the level of average interchange fees in the various systems.

The credit card interchange fee Standard specifies a benchmark, calculated by reference to issuers’ costs, and requires that the weighted-average interchange fee of each scheme be no higher than the benchmark at specific points in time. Under the original Standards, the benchmarks differed slightly across the schemes, reflecting differences in issuers’ costs. Following concerns by some industry participants that the scheme with the highest benchmark had a competitive advantage, a revised Standard was released in November 2005 after consultation with industry. Under this revised Standard, the same benchmark applies in both the MasterCard and Visa systems. That benchmark is currently 0.50 per cent of the value of a transaction.

The EFTPOS interchange fee Standard sets both a floor and a cap on interchange fees for EFTPOS transactions without a cash-out component. This approach reflects the bilateral nature of the EFTPOS system in which interchange fees are negotiated between each of the direct connectors in the system. The Board was concerned that these bilateral negotiations could be used to frustrate access or limit competition, with existing participants potentially offering arrangements to new participants on less attractive terms than were established with other existing participants. The cap is set as the average cost to an acquirer of authorisation and processing a transaction – currently $0.05 per transaction. The floor is 80 per cent of the cap – currently $0.04 per transaction.

The Visa Debit interchange fee Standard requires the weighted-average interchange fee in the Visa Debit system to be no higher than a benchmark set as the average cost to an issuer of processing and authorisation, expressed as cents per transaction. MasterCard's undertaking requires its debit interchange fees to meet the same benchmark. The benchmark is currently $0.12 per transaction.

While the interchange fee Standards use costs to calculate the benchmarks, at a conceptual level the Board does not see interchange fees as a way for acquirers to compensate issuers (or vice versa) for specific costs. Rather, the Standards have been based on costs as a way of establishing transparent benchmarks that meet the legal requirement of a ‘standard’.

The implementation of the set of interchange standards has resulted in lower levels of interchange fees and a smaller differential between the fees in the various systems (Graph 1). Interchange fees for credit card transactions have halved while those on scheme debit have fallen by a larger amount. Further, the difference in interchange fees between the EFTPOS and scheme debit systems has declined from around $1.15 on a $100 transaction prior to the reforms to around $0.17 currently.

3.2.3 Access

In order to promote competition in the payments system, the Board has also introduced a number of reforms to access arrangements.

In the credit card system, the effect of the previous access rules was to restrict membership of MasterCard and Visa to authorised deposit-taking institutions (ADIs) supervised by the Australian Prudential Regulation Authority (APRA). The credit card schemes argued that this was necessary for both their own protection and that of their members. While the Bank accepted the need for some entry criteria, it concluded that the then existing criteria were unnecessarily restrictive. It also concluded that the scheme rules that prevented institutions acting as acquirers only, or levied penalties on institutions that were significant net acquirers, unduly restricted competition.

Given that the schemes did not address these issues voluntarily, the Bank imposed access regimes on both the MasterCard and Visa credit card schemes. In doing so, it worked closely with APRA, which established a new class of supervised institutions known as Specialist Credit Card Institutions. The Access Regimes require the schemes to treat applications for membership from these specialist institutions on the same basis as those from the traditional ADIs, and prevent the schemes from imposing penalties on institutions on the basis of their issuing or acquiring volumes. Given the linkages between the credit and debit card schemes operated by Visa, and the structure of Visa's rules, it was also necessary for the Bank to impose a corresponding Access Regime on the Visa Debit system.

The Bank also concluded that access arrangements for the EFTPOS system were more restrictive than necessary, largely reflecting the bilateral nature of the system. While potential entrants could either negotiate access through an existing participant (which may also be a competitor) or establish their own direct links, existing participants were under no obligation to establish the necessary connections on reasonable terms and conditions, or to do so within a reasonable timeframe.

Following prompting by the Bank and the ACCC, industry participants spent considerable time developing an EFTPOS Access Code to improve access arrangements. Under the Access Code, which was adopted in September 2006, existing participants have agreed to procedures and timetables under which they will negotiate and establish connections with new participants. The Access Code also imposes a cap on the price that current participants can charge for new connections. This cap is set in the EFTPOS Access Regime imposed by the Bank and is the lowest cost of connection from a survey of direct connectors undertaken by the Australian Payments Clearing Association (APCA) in 2004 – it is currently $78,000. The EFTPOS Access Regime also limits the ability of existing participants to use negotiations over interchange fees to impede competition by imposing ‘no discrimination’ requirements on existing participants.

Footnote

At that time, Visa Debit was the only scheme debit system in operation in Australia. MasterCard's debit product was not launched in Australia until November 2005. [1]