Payments System Board Annual Report – 2009 Regulation of the Payments System

Review of the Payments System Reforms

In September 2008, the Board published the conclusions to its review of the payments system reforms. The review set out to examine: the effects of the reforms to date; the case for ongoing regulation; and, if the existing regulatory approach was to be retained, what changes if any should be made. Two consultation documents were issued during the review process – Reform of Australia's Payments System: Issues for the 2007/08 Review and Reform of Australia's Payments System: Preliminary Conclusions of the 2007/08 Review (Preliminary Conclusions) – and extensive industry consultations were held, including an industry conference in late 2007, hosted jointly with the Centre for Business and Public Policy at the Melbourne Business School.

Final conclusions of the review

In Reform of Australia's Payments System: Conclusions of the 2007/08 Review (Final Conclusions), the Board reaffirmed its view, expressed in the Preliminary Conclusions, that the reforms had met their key objectives of: increasing transparency; improving competition by removing restrictions on merchants and liberalising access; and promoting more appropriate price signals to consumers. Nevertheless, the Board concluded that the competitive forces acting on interchange fees remained relatively weak and, as a result, aspects of the payments system would continue to require close oversight.

The Board also confirmed its preliminary view that there was an opportunity for it to step back from the direct regulation of interchange fees, provided that industry participants took steps to reduce the risk that interchange fees would rise from their current levels in the absence of regulation. The Board identified two developments that could provide it with such comfort.

First, industry participants could take steps to further strengthen the competitive environment, such as:

• changes to the EFTPOS system, including the introduction of a central scheme and arrangements to effectively manage the system's development, reform of access arrangements, and the development of an alternative online payment instrument (either by the EFTPOS scheme or some other channel);
• further modification of honour-all-cards rules to ensure merchants would be able to separately decline or accept cards that attract different interchange fees; and
• increased transparency of scheme fees.

Second, the Board's concerns regarding upward pressure on interchange fees in the absence of regulation could be addressed through voluntary commitments from the schemes not to raise credit card interchange fees from current levels. This alternative was suggested in the course of consultation on the Preliminary Conclusions. The Board concluded that, if commitments were provided by the schemes, the further modification to honour-all-cards rules suggested in the first approach would not be necessary. The Board did not see the need to obtain similar commitments in respect of scheme debit or EFTPOS interchange fees, instead relying on the ability of merchants to steer transactions through the cheaper debit system to constrain the level of debit card interchange fees.

In the event that the industry failed to make sufficient progress in improving the competitive environment and the schemes did not provide voluntary commitments to cap interchange fees by August 2009, the Board concluded that a continuation of interchange regulation would be necessary. The Board maintained its view, expressed in the Preliminary Conclusions, that the credit card interchange fee benchmark should be further reduced to 0.30 per cent in this case. In response to consultation, however, the Board decided to adopt a more flexible common debit card interchange benchmark, requiring that the weighted average of interchange fees in each of the EFTPOS and scheme debit systems fall within a range between 5 cents paid to the issuer and 5 cents paid to the acquirer. Merchants had argued that the original proposal for a common benchmark of 5 cents paid to the issuer would remove any incentive for merchants to promote the use of the EFTPOS system.

The Final Conclusions also made clear that, irrespective of whether interchange fee regulation is removed, the Board required that the schemes continue to allow merchants to surcharge and make separate acceptance decisions for scheme debit and credit cards. The Board also sought greater transparency of scheme fees.

Industry progress

Following the release of the Final Conclusions, the Board closely monitored industry progress towards enhancing competition, and discussed the possibility of voluntary commitments to cap credit card interchange fees with the schemes. While progress was made in both these areas, the Board concluded in August 2009 that it was not sufficient to allow the removal of regulation.

In terms of enhancing competition, the Board recognised that the industry had taken a number of steps to address the Board's concerns. A new company to manage the EFTPOS system, EFTPOS Payments Australia Limited, was established in April 2009 with 14 initial members. The scheme board has eight initial industry-appointed directors, including representatives of both large and small financial institutions and large merchants. In addition, three independent directors have been appointed, one of which is Chairman of the company. The Board also noted the commitment of the industry to enhance the BPAY system to allow, among other things, online payments (known as Project MAMBO).

While these were important developments, and would potentially exert competitive pressure on interchange fees in the future, the Board was not convinced that the initiatives had yet reached that point. The Board therefore concluded that these developments were, by themselves, insufficient for it to be comfortable stepping back from regulation of interchange fees. Furthermore, despite the willingness of both MasterCard and Visa to work with the Bank to implement voluntary undertakings, the set of undertakings developed did not meet the Board's requirements. In these circumstances, the Board took the view that it would not be in the public interest to remove interchange regulation. However, given the progress that had been made, the Board decided to defer consideration of any further reduction in interchange fees. It indicated that it would keep matters under review, and would be prepared to re-open consideration of the regulations in light of industry developments.

In the meantime, the Board considered that the difference in regulatory treatment of the scheme debit and EFTPOS systems might be detrimental to competition. It therefore indicated its intention to consult on the possibility of changing the interchange regulation on the EFTPOS system to be consistent with that applying with respect to scheme debit. This consultation process has now commenced

Reform of the ATM System

On 3 March 2009, a package of reforms designed to improve competition in the Australian ATM system came into effect. As discussed in last year's Annual Report, the reforms were agreed by the industry in mid-2007 and were the outcome of many years of work by the industry, supported by the Reserve Bank. The main elements of the reforms included:

• an objective and transparent industry-developed access code, implemented through the Australian Payments Clearing Association (APCA);
• ATM owners having the freedom to charge cardholders directly for the use of an ATM, with any charge being disclosed to the cardholder prior to the transaction being finalised; and
• the abolition of bilateral interchange fees paid by banks and other financial institutions to ATM owners for the provision of ATM services.

• the new industry Access Code, combined with the removal of bilaterally negotiated interchange fees and a cap on connection costs would make access to the ATM system as a direct participant easier;
• greater transparency of ATM fees through disclosure at the ATM would directly benefit consumers and would promote greater competition on fees between ATM owners; and
• the greater flexibility in pricing allowed to ATM owners would enable deployment of ATMs in locations where they might not otherwise have been viable and provide a more sustainable business model for independent deployers.

Implementation of the reforms

Given that the broad details of the reform package were developed by industry, in consultation with the Reserve Bank, it had been anticipated that the reforms could be entirely implemented by the industry. However, while the industry was able to implement an Access Code, participants came to the view that additional legal certainty was required for two elements of the reforms – arrangements for setting interchange fees to zero and establishment of a cap on the cost of connection to the ATM system. In September 2008 the industry asked the Bank to use its regulatory powers to provide the required certainty.

In December 2008, the Bank designated the ATM system and released a draft Access Regime for consultation. The draft Regime addressed the two areas where intervention was requested by the industry, and also set out limited circumstances under which interchange fees could continue to be paid.

After a period of consultation, involving both written submissions and meetings with interested parties, the ATM Access Regime was finalised and came into effect on 3 March 2009 – coinciding with the implementation of the Access Code and the start of direct charging at ATMs.

The Access Regime imposed a cap on the fee that each existing direct participant in the system could charge a new entrant for establishing a bilateral connection. The cap was set at $76,700, the lowest cost of providing a connection reported to APCA in a survey of participants in mid-2008. The Board was of the view, however, that direct clearing and settling arrangements are fundamental aspects of banking business and the Access Regime prohibited charging of fees for establishing such arrangements.

The Access Regime eliminated interchange fees in the ATM system in most circumstances. The Board recognised, however, that interchange-like fees could be pro-competitive in some circumstances. In particular, fees that allow small institutions access to a larger network of ATMs than they would be able to provide themselves, free of direct charges, could help those institutions to compete on a more equal footing with the larger players in the industry. To that end, the Access Regime allowed interchange fees to be paid between members of an ATM sub-network – in line with the original industry proposal. The Regime also allowed institutions to establish one-way arrangements in which they pay fees to an ATM owner so that their customers can access those ATMs without a direct charge being levied. Institutions were only permitted to access one additional network of ATMs in this way.

In addition, during the consultation process it was suggested that some flexibility be incorporated into the Access Regime through an exemption power. The Board saw merit in this suggestion, particularly given the wide variety of business and technical arrangements in place across the ATM system and the likelihood that in some circumstances payment of an interchange-like fee may be in the public interest. A clause was therefore incorporated into the Access Regime, allowing the Bank to grant an exemption to the interchange fee provisions and setting out the matters that the Bank would take into account in doing so. Notice of any exemptions granted would be published on the Bank's website.

Early effects of the reforms

Early evidence suggests that the reforms are having the anticipated effect. Customers appear to be responding to more transparent pricing of foreign ATM transactions, deployment of ATMs appears to be expanding and there has been some early evidence of direct price competition.

The overall cost of a post-reform foreign ATM transaction in many cases is similar to that prior to the reforms. For instance, a major bank customer making a foreign ATM withdrawal prior to 3 March would have paid a $2.00 foreign fee to their own bank, but no fee directly to the ATM owner. Within a short period of the implementation of the reforms, most institutions had ceased levying foreign fees. Customers making a foreign transaction are therefore now paying only the direct charge levied by the ATM owner. Most owners charge $2.00 across their networks for a withdrawal, but some charge a lower fee, meaning that customers can pay less than $2.00 by shopping around. One major bank, for instance, charges $1.50 for a withdrawal and some owners are charging as little as $1.00. On the other hand, there are some reported instances of direct charges being higher than $2.00. Direct charges on balance enquiries vary: in some cases there is no charge but in other cases, the charge is the same as for a cash withdrawal (Table 7).

For the most part, there has been little change in the level of direct charges since their introduction in March, although there is anecdotal evidence that some owners have lowered fees on individual machines.

The greater transparency of fees following the reforms appears to have made cardholders more sensitive to the cost of foreign ATM transactions. There was a marked shift away from foreign ATMs, towards use of cardholders' own institutions' ATMs, in March 2009 and this has largely been maintained (Graph 22). As a share of total ATM transactions, foreign transactions fell from an average of around 47 per cent in the year prior to the reforms, to 38 per cent in March 2009. Average withdrawal amounts have also increased, particularly at foreign ATMs.

There is also evidence that the reforms have altered the competitive dynamics in the ATM system. Financial institutions view the capacity to offer customers a sizeable network of fee-free ATMs as critical to their ability to compete. This has seen many institutions take up the flexibility provided by the ATM Access Regime to gain access to a wider network of ATMs by joining a sub-network or entering a one-way agreement with another network. In mid June, for example, the National Australia Bank (NAB) entered into an agreement to join Cuscal's RediATM sub-network. Cuscal sought guidance from the Reserve Bank as to whether this agreement would be consistent with the spirit of the Access Regime. The Board was of the view that the agreement would be pro-competitive and within the spirit of the reforms. It was also satisfied that the payment of an interchange fee by a major bank within a sub-network arrangement does not give rise to access concerns, provided that those fees are common to all members and the criteria for membership of the sub-network are fair, objective and transparent. In addition, the Board was of the view that the expansion of the RediATM network would increase the capacity of many small financial institutions to compete with banks offering the largest networks, promoting competition between card issuers and providing benefits to customers of NAB and RediATM members through an improvement in the availability of fee-free ATMs.

As an alternative to sub-network arrangements and one-way agreements, other larger issuer-owned networks appear to have been expanding their ATM fleets. At the same time independent ATM deployers have been exploring strategies to take advantage of the new pricing arrangements and the changed focus of issuers. Among other things, there is evidence that greater pricing flexibility is attracting new deployers into the market.

The reforms have yet to be tested in terms of access, with no new direct connections or direct clearing/settlement arrangements having been established. While the Board is satisfied that the reforms have improved access, it nevertheless sees a need for more fundamental reform of the architecture of both the ATM system and the EFTPOS system. The Board noted in its December 2008 consultation document on the ATM Access Regime that the current technology underpinning the ATM and EFTPOS systems will need to be updated over the next year or so and that this provides an opportunity for the industry to improve the architecture of these systems in a way that promotes efficiency and supports more open access. The Board is aware that the industry is working on this issue and it will be taking an active interest in progress over the coming year.

Overseas Developments

Overseas, there has been continued regulatory interest in the operations of card schemes, particularly interchange fees.

In Europe, the European Commission (EC) reached an agreement with MasterCard on cross-border interchange fees.^[3] In December 2007, the EC ruled that MasterCard's cross-border interchange fees were illegal under European Union competition law. As a result, MasterCard was required to remove its interchange fees on cross-border card transactions using MasterCard and Maestro-branded debit and consumer credit cards by June 2008. Since then, MasterCard has been in discussions with the EC on an appropriate methodology to determine its cross-border multilateral interchange fees (MIFs).

As a result of these discussions, MasterCard provided three undertakings to the EC. In return, the EC agreed not to pursue MasterCard further on its MIFs. The undertakings were that from July 2009:

• the cross-border MIF would be calculated based on the savings to merchants obtained from transactions being made using cards rather than cash. The resulting maximum weighted average MIF was determined to be 0.3 per cent per transaction for consumer credit cards (down from a range of 0.8 to 1.9 per cent in 2007) and 0.2 per cent per transaction for consumer debit cards (down from a range of 0.4 to 0.75 per cent in 2007);
• scheme fee increases announced in October 2008 would be repealed;^[4] and
• there would be improvements to transparency, including merchants being offered and charged different rates for different cards (unblended rates).

The EC is continuing its antitrust investigations into Visa which commenced in March 2008 when a 2002 exemption expired. The EC sent Visa a ‘Statement of Objections’ on 3 April 2009 outlining its preliminary view that MIFs set directly by Visa infringe European Union competition law.^[5] The Statement of Objections also suggested that other system rules and practices restrict merchants' ability to manage their payments costs. The EC specifically mentioned the honour-all-cards rule, the no-surcharge rule and the blending of merchants' fees.

In New Zealand, the Commerce Commission reached agreements with MasterCard and Visa to alter a number of their practices.^[6] MasterCard and Visa have each agreed to make changes to the way their rules apply in New Zealand. In particular:

• credit card issuers in each of the schemes will be able to individually set their interchange fees, subject to maximum rates determined by the schemes;
• merchants will not be prevented from applying surcharges and will be able to encourage customers to pay by means other than a credit card; and
• non-bank organisations that wish to provide acquiring services will be permitted to join the schemes provided they meet relevant financial and prudential criteria.

On the basis of these agreements, the Commerce Commission discontinued its proceedings against the schemes.

In other countries, there have been enquiries into scheme practices. The US government initiated a study into credit card interchange fees, examining a range of issues including the ability of merchants to negotiate pricing with network operators and card issuers. The study is required to recommend appropriate legislative and administrative actions.

In Canada a Senate Standing Committee conducted an inquiry into the operation of credit and debit card systems in Canada. While only an advisory body, the Committee made a number of recommendations including: permitting merchants to bargain collectively with scheme operators and card issuers; allowing merchant surcharges; prohibiting ‘honour all cards’ rules (including those requiring merchants to accept a scheme operator's higher-cost premium cards); and setting all debit card interchange fees to zero for three years.

Footnotes

See <http://europa.eu/rapid/pressReleasesAction.do?reference=IP/09/515&format=HTML&aged=0&language=EN&guiLanguage=en> [3]

In September 2008, MasterCard Europe notified significant increases in its ‘card scheme fees’ from 1 October 2008. This drew complaints from merchants and the EC was considering whether the action represented an attempt to circumvent the ban on cross-border MIFs. [4]

See <http://europa.eu/rapid/pressReleasesAction.do?reference=MEMO/09/151&format=HTML&aged=0&language=EN&guiLanguage=en> [5]

See ‘Commerce Commission and MasterCard agree to settle credit card interchange fee proceedings’ at <http://www.comcom.govt.nz/media-releases/detail/2009/commercecommissionandmastercardagr> and ‘Commerce Commission and Visa reach agreement to settle credit card interchange fee proceedings’ at <http://www.comcom.govt.nz/media-releases/detail/2009/commercecommissionandvisareachagre> [6]