The Operation of the Interchange Standards: Conclusions Paper 2. Introduction
2.1 Background to the consultation
In 2015–16, the Bank conducted a review of its card payments regulation, which concluded with new Standards relating to interchange fees and merchant pricing in designated card schemes.[4] The interchange standards introduced new requirements relating to the payment of ‘net compensation’ to issuers. These requirements were designed to prevent the caps placed on interchange fees being circumvented by arrangements involving non-interchange payments or other incentives being provided by schemes to issuers (see Box A).
Under the Standards, schemes and issuers in designated schemes are required to certify to the Bank annually that they have complied with the net compensation provision. The initial certifications were provided to the Bank in August 2018. This initial certification process indicated that the new Standards were working as intended from a broad policy perspective. However, it also suggested that there were some issues with the interpretation of the net compensation provision that might benefit from clarification, and areas where some potential minor variations to the Standards might be beneficial.
Accordingly, the Bank sought informal views from stakeholders on the operation of the net compensation requirement. On 28 February, the Bank published a Consultation Paper on the Operation of the Interchange Standards.[5] The Consultation Paper described the issues where stakeholders have sought clarification and guidance or suggested changes to the Standards, and set out the Bank's proposed options to address them. It also set out draft variations to the Standards to illustrate how the Bank proposed to implement these changes. The Bank invited interested parties to make submissions in writing on the Consultation Paper and draft variations to the Standards by 28 March.
Box A: Interchange Fees, Issuer Incentives and Net Compensation
Debit and credit cards are the most frequently used non-cash payment instruments in Australia. The four largest banks are the main issuers of these cards although there is also issuance by a number of other financial institutions, both Australian and foreign-owned. Currently, around 85 per cent of the value of transactions in the credit and charge card market are processed through the international ‘four-party’ (Mastercard and Visa) networks and around 15 per cent through the ‘three-party’ (American Express and Diners Club) networks. All debit and prepaid card transactions are processed through four-party schemes (Debit MasterCard, eftpos and Visa Debit).
In four-party schemes, interchange fees are wholesale fees paid by the merchant's financial institution (the acquirer) to the cardholder's financial institution (the issuer) when a cardholder undertakes a transaction. While there may be a useful role for interchange fees when a card network is first established, the case for significant interchange fees in mature card systems is much less clear.[6] Where merchants typically accept most or all types of cards, and where cardholders hold one type of card or have a preferred card, competition between schemes tends to result in increases in interchange fees, which are incorporated into higher fees charged to merchants.
Accordingly, to improve efficiency in the payments system, the Bank established regulatory standards in relation to interchange fees in the early to mid 2000s. These have had the effect of reducing the average level of interchange fees in the international four-party systems and prevented the significant upward movement in interchange fees that has occurred in other markets.
In 2016, the Bank introduced new requirements relating to the payment of ‘net compensation’ to issuers. These requirements were designed to prevent the caps placed on interchange fees being circumvented by arrangements involving non-interchange payments or other incentives being provided by schemes to issuers.
The key concept underlying the ‘net compensation’ provision is that while caps on interchange fees can limit amounts paid between acquirers and issuers, participants in a payments network can recreate interchange-like flows through the operation of scheme fees and rebates (and other non-rebate incentives). Issuers and acquirers generally pay fees to schemes for the services that the schemes provide. Schemes sometimes provide discounts and rebates on these fees, particularly to issuers, and they may make various payments to issuers which may be to encourage issuance of that scheme's cards, or to establish card issuance exclusivity arrangements. Where acquirers and issuers pay fees to schemes and the scheme provides to the issuer rebates or other incentives of more than the amount of fees paid by the issuer, the net result is a value flow from acquirer to issuer which is economically equivalent to interchange fees (Figure 1). In the example provided in Figure 1, an interchange-like flow of 10 basis points (bp) occurs between the acquirer and the issuer, comprising a 10 bp scheme fee paid by both parties and a 20 bp rebate paid by the scheme to the issuer. The Standards implement a restriction on net compensation by establishing two defined concepts: Issuer Receipts and Issuer Payments, and stipulate that the former cannot be larger than the latter.
2.2 Consultation Process
The Consultation Paper was published on the Bank's website on 28 February. Notification of the publication was sent to the 38 entities that had contacted the Bank regarding their compliance with any of the Bank's card payments regulations (that is, the interchange standards, as well as Standard No. 3 of 2016 that covers scheme rules relating to merchant pricing for credit, debit and prepaid cards, and the card system Access Regimes). This group included a mix of schemes and issuers, with the latter including direct issuers, aggregators (also known as scheme sponsors) and downstream issuing entities.
The Bank received ten written submissions in response to the Consultation Paper. Submissions were received from schemes, banks[7] and one aggregator.[8] All non-confidential submissions have been published on the Bank's website. The Bank also met with nine stakeholders.
In response to stakeholder feedback, the Bank drafted a revised definition of ‘Core Service’ (previously Core Services). As discussed in the Consultation Paper, the Bank proposed to clarify that ‘Issuer Payments’ are those payments made by issuers in relation to core services of a scheme. In forming the revised definition of Core Service the Bank drew on both the input provided in written submissions and meetings, and on additional information and perspectives a number of stakeholders provided in April at the Bank's request. The Bank circulated the revised definition of Core Service to stakeholders on 30 April and invited feedback by 3 May.[9] The short timeframe for feedback on this revised definition reflected that it dealt with a specific issue on which stakeholders had already provided feedback, as well as the Bank's intention to take a proposal to the May meeting of the Payments System Board. Nine stakeholders provided their views on the revised definition; these included views from schemes, banks and aggregators.
The Bank also sought input from Accounting Standards experts.
Endnotes
See ‘Review of Card Payments Regulation – Conclusions’, Reserve Bank of Australia, Sydney, May 2016. [4]
See ‘The Operation of the Interchange Standards: Consultation Paper’, Reserve Bank of Australia, Sydney, February 2019. [5]
For further discussion see ‘Review of Card Payments Regulation – Conclusions’, Reserve Bank of Australia, Sydney, May 2016, pp.7-9. [6]
All responding banks are both issuers and acquirers in the Australian market. [7]
Four were received after the requested submission date of 28 March. [8]
The revised definition of core service was circulated to entities that had contacted the Bank regarding their compliance with any of the Bank's payment cards regulations. [9]