The Operation of the Interchange Standards: Conclusions Paper 5. Issuer Payments as Payments for ‘Core Services’

5.1 Issues for consultation and proposed options

The net compensation provisions were introduced in 2016 as a means of ensuring that incentives to issuers could not be used to circumvent the Bank's interchange fee caps (See Box A). The Standards implement the 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.^[22]

In determining their net compensation compliance certification for the first reporting period in mid 2018, some stakeholders sought clarity on what could be considered Issuer Payments under the Standards. ‘Issuer Payments’ effectively sets an upper limit for financial incentives and other benefits that can be provided to the issuer without breaching the requirement that there be no net compensation. In particular, stakeholders sought clarification on whether the Standards intended to capture, as Issuer Payments, fees for services that are not essential to the issuance or use of cards, for example, fees paid for the provision of loyalty services. Stakeholders noted that there were inconsistent views across the industry on this matter. In addition, some stakeholders noted that schemes differ in the breadth of auxiliary services they offer. A wide interpretation of Issuer Payments could, in theory, facilitate one scheme being able to offer more incentives to an issuer than another scheme with a more limited set of services.

Under the Standards, Issuer Payments are essentially the total amount of fees (or ‘Benefits’) related to cards or card transactions that are paid by an issuer to the scheme. The Standards refer to these as including ‘Scheme branding fees; processing fees; and assessment fees’. The Consultation Paper proposed to improve the clarity of the definition in a manner consistent with the original purpose and intent of the Standards by explicitly defining Issuer Payments as those payments made to schemes (or their associated entities) for ‘Core Services’ provided by the scheme (or their associated entities) to the issuer. To give effect to this proposal, the Bank would need to define Core Services.

In the Consultation Paper, the Bank set out a definition of Core Services which, broadly speaking, entailed those services that are the minimum necessary for the issuer to effectively participate in a scheme, and without which it would not be possible to be an Issuer (directly or sponsored) and which are provided to issuers in the scheme globally in exchange for scheme and other processing fees (see Box C). These services are likely to include the licensing of scheme branding, as well as transaction processing and assessment services, and basic relationship management services. As issuers may not have visibility over all services that a scheme provides to other issuers globally, this approach required schemes to notify their issuers of the services that met the ‘provided globally’ test.

This Consultation Paper version of the Core Services definition made it clear that fees or payments for tangential card-related services – such as the loyalty services example raised earlier by stakeholders – are not captured in Issuer Payments. The Bank noted that a particularly wide definition could enable an extensive range of payments made for bundled and optional services to be included in Issuer Payments, creating potential for substantial payment of incentives to particular issuers. The scope for this to occur could grow as schemes become involved in more parts of the payment value chain and provide a wider range of services to issuers. In view of this, and the likelihood that an increase in incentives paid will lead to an increase in merchants’ costs of accepting card payments (similar to an increase in interchange fees), a wide definition of Issuer Payments is unlikely to be in the public interest or consistent with the original purpose and intent of the Standards.

In addition, in the Consultation Paper, the Bank proposed that the definition of Issuer Payments specify that only payments for core services can be included, rather than other forms of consideration such as rebates, refunds, allowances, discounts or deductions, as is the case in the current version of the Standards. This change is to simplify and improve the clarity of the Standard. The Bank expects that this modification is unlikely to have a material impact, given that the vast majority of, if not all, consideration for a scheme's core services is in the form of amounts paid or payable.

In response to feedback (discussed below), the Bank drafted a revised definition of Core Service (previously Core Services) for additional stakeholder consultation (see Box C). The revisions sought to address a range of concerns raised by stakeholders, and incorporate new information obtained from the consultation process (from the written submissions, stakeholder meetings and subsequent information requests). Notably, in the revised version the ‘provided globally’ test was removed. In addition, the revised version specified that a Core Service could only be one of a limited set of service types. It also drew on the views of some stakeholders that a service should not be considered a Core Service of the scheme (or a scheme's associate entity) if it could be provided by a third party or produced in-house by the issuer. Throughout the consultation process, the Bank actively engaged with stakeholders on the Core Service(s) definition and possible revisions.

5.2 Stakeholder views

A substantial majority of stakeholders supported, in principle, Proposal 2. That is, the concept that Issuer Payments are those payments made by issuers in relation to core services of a scheme. No respondents objected to the idea Issuer Payments should only relate to Payments rather than Benefits. However, many respondents considered the specific definition of Core Services drafted by the Bank to give effect to the proposal to be too narrow. Three respondents objected to the proposal in its entirety.

Objections to the principle of defining Issuer Payments as payments for core services

Of the three respondents that objected to the proposal in its entirety, two suggested that the current definition of Issuer Payments should be retained. They suggested that the Bank could provide sufficient clarification of the current definition of Issuer Payments by adding an exclusions list.

A small number suggested that the proposal would materially change the definition of Issuer Payments, with a potentially substantive effect. They submitted that such a change should not be contemplated in this consultation, but as part of the Bank's periodic comprehensive review of the regulatory framework. In contrast to this view, many stakeholders described the expected impact of the proposed variations to be relatively small.

Another stakeholder suggested that Issuer Payments should be defined in relation to the scheduled fees a scheme has published to its issuers, rather than a definition of core services. This reflected a concern that definitions can be vulnerable to circumvention. Under its proposed approach, schemes would only be able to include in Issuer Payments a fee for which:

1. the scheme has published that fee to all issuers of the scheme; and,
2. the fee relates to payments initiated in Australia for the purchase of goods and services (excluding international e-commerce);

The stakeholder proposed that Schemes be required to disclose to the Bank all fees that applied to issuers during each reporting period, which would assist the Bank in verifying compliance. It noted that this approach would also increase the transparency of scheme fees. Discussion with other stakeholders suggested the schemes’ fee schedules can be complex. Some schemes were said to have thousands of different types of scheme fees. However, several entities noted that a relatively small number of fee categories accounted for the vast majority of fees paid to schemes.

Comments in relation to the definition of core services set out in the Consultation Paper

Although a substantial majority of stakeholders supported, in principle, Proposal 2, many considered the specific definition of Core Services suggested by the Bank to give effect to the proposal to be too narrow.

Many stakeholders raised concerns that the ‘provided globally’ element (part (c)) of the Core Services definition set out in the Consultation Paper was too restrictive. A common view was that services that are core in Australia may not be provided by a scheme in other markets. For example, one respondent stated that in some countries schemes do not provide transaction processing services. Some also noted that Australia is often used as a test market for innovations (such as contactless technology), and that as a result some services will be taken up in Australia sooner than in other countries. A small number of respondents commented that the ‘provided globally’ test would make issuers overly reliant on schemes in determining which services are core.

Some stakeholders commented that other elements of the definition were too restrictive, namely the requirements that Core Services are:

• the minimum necessary services for a participant to issue, and administer transactions made using, a Device of the Scheme that can be used to make payments for goods or services; and,
• without which it would not be possible to be an Issuer of the scheme (directly or sponsored).

Some stakeholders suggested that ‘minimum necessary’ and ‘without which it would not be possible’ should be replaced with less restrictive wording, such as ‘unavoidable’ or ‘minimum expected capability’, respectively. An alternative suggestion was that the definition should refer to the minimum necessary services to ensure the integrity of the system, rather than the minimum necessary services to issue and administer transactions.

Several respondents suggested that the definition of Core Services should be considered from the perspective of cardholders. For example, that Core Services be the minimum necessary services needed to meet cardholders’ expectations or, alternatively, those services necessary for an issuer to be able to compete effectively for prospective cardholders. Several stakeholders noted that fraud prevention services, which are not mandated by the schemes, are generally expected by cardholders.

One view put forward in consultation was that a service should not be considered to be a Core Service of the scheme (or any of its associated entities) if it could be provided by a third party or produced in-house by the issuer. Others suggested that schemes are often best placed to provide – or more efficient at providing – certain services, even when there are third-party providers. Some stakeholders asserted that such services should be considered core. In particular, it was suggested that schemes are better placed to provide services that relate to the entire system and for which real-time action is critical to the integrity of the network, for example some types of fraud prevention services.

Stakeholders generally agreed that all scheme-mandated services should be considered core. However, some issuers raised concerns that schemes may choose to mandate a wider range of services if this criteria was included in the definition of Core Services. Others suggested that Core Services should be wider than just mandated services.

A few respondents suggested that the definition should include a list of services that are core and/or a list of services that are not core. While some entities provided examples of the services that they considered to be core, there was no consensus across respondents on the services listed. Some noted that it would be desirable for the definition to be drafted in a way that it would not need to be regularly updated, for example to account for technological changes.

Some commented that it would take significant time and resources to distinguish Core from non-Core Services based on the proposed definition. For some schemes, verifying services against the global test would be an extensive exercise. This notwithstanding, stakeholders expected that the cost of identifying Core Services would largely be limited to the period where entities transitioned from the current Standard to the varied Standard.

Comments on the revised definition of Core Service circulated to stakeholders on 30 April

In response to stakeholder feedback, the Bank drafted a revised definition of Core Service (previously Core Services) for stakeholder consultation (Box C). Many respondents acknowledged that the revised definition had addressed some of their concerns. Some stakeholders noted that they were comfortable with the revised definition, however others suggested that the definition remained too narrow. A small number of stakeholders that had previously objected to Proposal 2 in its entirety continued to argue against the proposal.

Some entities sought clarification on whether some specific service types would be captured as a Core Service, or relatedly whether specific fees would be included as Issuer Payments, under the revised definition. The services queried included: basic relationship management services, scheme compliance (including licensing, mandated releases, article updates), card management services, POS device Issuance, scheme-mandated product features and regulatory compliance. The fees queried included: assessment fees and other fees linked to the number of cards issued, reversal fees, access fees, testing fees and concierge fees. One respondent indicated the fees charged by some schemes change frequently, and that the names of fees do not necessarily clearly reflect the service being provided for that fee.

A number of respondents proposed modifications to the definition. One entity suggested that the Bank use a definition that includes products (i.e. broadening the defined term from Core Service to Core Service or Product). In consultation, several other stakeholders described schemes as providing products as well as services. Another entity submitted that if authorisation services were added to part (c)(ii) of the proposed definition, part (c)(iii) would not be required. Others suggested modifications based on incorporating either the issuer's or the cardholder's perspective on what is a Core Service. One entity commented that different issuers have different views on what they consider ‘core’. In a small number of cases, respondents expressed concerns about the requirement that a Core Service would be defined as something without which it would not be possible to be an issuer of the scheme (directly or through sponsorship) (part (b)). A concern here was that this introduced a material change from the current Standards.

A few stakeholders commented specifically on the requirement that particular types of services are only core if they can only be provided by the scheme (or any of the scheme's associated entities) for technological or operational reasons given the configuration of the systems of the Scheme to process transactions (in other words, excluding services that could be provided by a third party or performed by the issuer in-house). Some respondents held the view that the additional test would restrict issuer payments too narrowly. One entity indicated that it was likely to face significant difficulty in determining whether a particular service could – in theory – be provided by an alternative source to the scheme (or a scheme-associated entity). Drawing on an observation that for certain services the scheme will be the most efficient provider, but not the only possible provider, one entity suggested that this element of the definition (part (c)(iii)(B)) be replaced with a concept linked to efficiency. For example, that a service would be core if, for technological or operational reasons given the configuration of the scheme's systems to process transactions, an issuer receives the service from the scheme on efficiency grounds.

There was broad support for the inclusion of the reference to associated entities of a scheme in part (c)(ii)(B) of the revised definition.

In relation to compliance costs under the revised definition of Core Service, schemes noted that time and resources will be needed to identify which services are core and the fees attributable to them. Some indicated that the revised definition might necessitate the re-negotiation of contracts to ensure compliance with the Standards.

5.3 Assessment and Conclusion

Given the in-principle support from most respondents, the Bank has decided to proceed with adopting Proposal 2. The Bank appreciates the considerable input that the industry has provided over recent months in relation to the drafting of the definition of Core Service. The Bank has further refined the definition to reflect the most recent round of stakeholder consultation. The Bank carefully considered the views of those stakeholders who made submissions on Proposal 2, and an assessment of these is set out below.

Defining Issuer Payments as those payments made by issuers in relation to core services of a scheme

In the Bank's view, it is consistent with the purpose and intent of the Standards to define Issuer Payments as those payments made by issuers in relation to core services of a scheme (Proposal 2). In drafting the current Standards, the Bank envisaged that only a narrow set of scheme fees would be included as Issuer Payments. This is reflected in the examples of Issuer Payments provided in the Standards, namely scheme branding fees, processing fees and assessment fees. These are fees for services that the Bank understood to be essential and unavoidable to participate in the scheme. In putting forward Proposal 2, the Bank sought to provide greater clarity to stakeholders about what was, and was not, intended to be captured in Issuer Payments.

Proposal 2 is consistent with the original purpose and intent of the definition of Issuer Payments. It is possible that, if a scheme or issuer has previously taken a particularly wide interpretation of the current definition of Issuer Payments, the consequence of adoption of Proposal 2 could be a material change in the quantum of Issuer Receipts flowing from a scheme to an issuer in the future. If schemes and issuers have been taking a particularly wide interpretation of Issuer Payments, then this strengthens rather than diminishes the case for adopting Proposal 2. In the Bank's view, it is in the public interest to adopt Proposal 2 to confirm the purpose and intended outcome of the Standards even if doing so may have particular implications for some stakeholders. The Bank notes that it has included transitional arrangements for the variation to the Standards that enable issuers to comply with the existing Standards for the 2018/19 reporting period and move to the revised Standards for the 2019/20 reporting period (see Section 9).

The suggestion that Issuer Payments be, broadly speaking, tied to published scheme fees associated with payments initiated in Australia (rather than Core Services) raises a number of important questions and the Bank expects that there would be a diversity of views on these matters. Given this, and the in-principle support for the proposal the Bank put forward, it was decided not to consider this alternative, in its entirety, any further at this time.

This alternative also proposed that schemes disclose to the Bank all fees that applied to issuers during each reporting period. In the Bank's view, this would assist the Bank in verifying compliance. However, the Bank notes that it has information gathering powers under which it could acquire this information. Accordingly, it is not necessary to include this requirement in the Standards.

This alternative also raised a number of important issues that are outside the scope of this consultation. These largely relate to scheme fees, and include the question of whether complexity and opacity of scheme fees may be inhibiting competition and/or efficiency in the cards market. These issues would be best considered in the next comprehensive review of the regulatory framework.

Definition of core service

The Bank noted stakeholder feedback that the ‘provided globally’ element of the proposed definition might be overly restrictive, as there are some services that may be necessary for participating in a scheme in Australia that are not provided to issuers of the scheme globally. This element of the definition was removed in the revised version circulated to stakeholders in April.

A recurring theme in the consultation was the suggestion that Core Services should be defined in relation to either issuer or cardholder expectations, rather than the minimum services required to issue cards, and administer transactions, and without which it would not be possible to be an Issuer (directly or sponsored). This suggestion was not adopted. In the Bank's view, doing so would introduce scope for the definition to be interpreted much more broadly, and thus would not address some of the key issues raised in the initial call for views on the operation of the Standards. In addition, the consultation revealed that there is not a consistent view across issuers on what each considers to be the core services provided by schemes. It is worth noting that the definitions of Core Service(s) the Bank has proposed do not prevent an issuer from purchasing non-Core Services from a scheme to deliver additional services to their cardholders.

The Bank responded to stakeholder views that the definition could offer more clarity by including a list of services that could be considered a Core Service. By making such a list exclusive, this would also provide clarity on the types of services that are not to be considered core. The revised definition circulated by the Bank in April incorporated such a list. This list was segregated, with a portion of the services listed subject to a further test that incorporated the concept that if a service could be provided by a third party, or be produced in-house by the issuer, then it should not be considered a Core Service of the scheme. This additional test sought to address the mixed views across stakeholders as to whether the services in the list should be considered core. The inclusion of this list meant that the ‘minimum necessary’ test (part (a) of the definition proposed in the Consultation Paper) was not needed, and it was removed in the revision.

In responding to the revised definition, some stakeholders advocated for the removal or substantial modification of the additional test in relation to whether a service can be provided by an entity other than the scheme. The Bank acknowledges that this additional test added a layer of complexity and that there may be practical difficulties to its implementation, so it has decided to not include it.

In the Bank's view, the final definition for Core Service (see Box B) provides the industry with a much clearer picture of the intended scope of the definition of Issuer Payments, compared with the current definition. The final definition will limit the scope for substantial payments of incentives to particular issuers.^[23] Under the current definition of Issuer Payments, there is greater scope for this to occur when a scheme offers a wide range of card related services that are not Core Services. As discussed above, an increase in incentives paid to issuers is likely to lead to an increase in merchants’ cost of accepting card payments (similar to an increase in interchange fees), and accordingly the Bank considers that a definition of Issuer Payments that is limited to payments for Core Services is in the public interest.

In relation to products provided by a scheme, the Bank notes that the term ‘product’ has traditionally referred to tangible personal property that is grown, manufactured, refined or otherwise physically produced for sale. In the financial services context the term has come to be used in a sense that does not involve tangible personal property, but in that context the term typically refers to a service that has been created to serve a need and that is marketed or sold as a commodity. In view of this, the Bank's view is that the term ‘service’ is the appropriate term. The fact that a service is labelled or marketed as a ‘product’ will not prevent it being a Core Service, provided it is in fact a service and meets the three tests in the definition of that term.

In relation to queries concerning whether specific services are Core Services, or whether particular fees should be captured in Issuer Payments, stakeholders should look to the final definition of Core Service (Box D). In addition, the Bank makes the following observations:

• Feedback from stakeholders indicates that the definition to be adopted is consistent with including in Issuer Payments the three types of fees provided as examples of Issuer Payments in the current version of the Standards, namely scheme branding fees, processing fees and assessment fees;
• Schemes and issuers should look beyond the names of fees to determine whether they are, indeed, payment for core services. As noted by a respondent, fee names can change from time to time and may not clearly indicate precisely what product or service the fee is for. Schemes should consider whether the information they provide on fees is sufficiently clear to enable issuers to easily identify what the fees they pay relate to.
• The definition of Core Service determined by the Bank requires that the service relates to, and only to, one or more ‘Core Functions’. However, it allows for a scheme to provide incidental services necessary to support Core Functions without this affecting whether a service meets the definition of Core Service or not. Accordingly it allows for some basic relationship management assistance to be provided in conjunction with a service, without that service being precluded from being a Core Service.

To assess the operation of the varied definition of Issue Payments, the Bank may request, from time to time, that an entity provide the Bank with a list of the fees it has included in its calculation of Issuer Payments and the services provided for those fees. The Bank expects to make this request to schemes and to a sample of issuers when they certify their compliance in relation to the varied standard for the first time.

Endnotes

As noted earlier, in the proposed changes to the standards, the terms Issuer Receipts and Issuer Payments are replaced by terms ‘Direct Issuer Participant Payment’ and ‘Direct Issuer Participant Receipt’. For ease of reference, this consultation paper retains usage of the terms ‘Issuer Payments’ and ‘Issuer Receipts’. [22]

Of note, in forming the definition of Core Service, the Bank took account of the proposed modifications to the set of entities that can receive Issuer Payments to ensure that the overall varied definition of Issuer Payments remains consistent with the original purpose and intent of the Standards. As noted in Section 4, the Bank intends to vary the set of entities that can receive Issuer Payments to include the associated entities of the scheme. This is to enhance consistency across the proposed definitions of Issuer Receipts and Issuer Payments. It also clarifies that the corporate structure of the scheme should not affect whether a particular Benefit is an Issuer Payment or not. [23]