Review of the Regulatory Framework for the EFTPOS System: Consultation on Options for Reform – June 2012 2. Background

Development of the Current Regulatory Framework for the EFTPOS System

The current regulatory framework for the EFTPOS system was put in place by the Board to address concerns regarding: the nature of competition between the EFTPOS and scheme debit card systems; the effect of the difference in interchange fees in the two types of systems on efficiency in the payments system as a whole; and the difficulties faced by entrants seeking access to the EFTPOS system. These concerns were initially identified in the context of joint work undertaken by the Reserve Bank (the Bank) and the Australian Competition and Consumer Commission (ACCC).^[1] This study found that the difference in interchange fees between scheme debit and EFTPOS (of up to $1.15 on a $100 transaction) did not reflect the underlying costs of each system, and was likely to distort consumers' choice of payment instruments in a way that was detrimental to the efficiency of the overall payments system.^[2] It also found that bilateral negotiations over access disadvantaged smaller providers seeking entry to the EFTPOS system.

In response to these findings, and with encouragement from the Bank, the industry developed a proposal to set interchange fees in the EFTPOS system to zero and applied to the ACCC for authorisation for this arrangement. After the ACCC's initial authorisation was overturned on appeal, the Board came to the view that the prospect for further industry-based reform was limited and it designated the EFTPOS system in September 2004.

Interchange Fees Standard

The interchange fees Standard for the EFTPOS system was imposed by the Bank in 2006. The Standard sets both a floor and a cap on bilateral interchange fees for EFTPOS transactions without a cash-out component. The floor and cap approach was taken because of the bilateral negotiations required to access the EFTPOS system. The Board's concern was that, without a cap and a floor, new entrants might not be able to negotiate interchange fees on as favourable terms as existing participants, which could be detrimental to competition and efficiency. The cap – currently $0.05 paid to the acquirer – was set based on the cost to the acquirer of authorisation and processing of EFTPOS transactions. The floor is specified to be 80 per cent (currently $0.04) of the cap paid to the acquirer. The introduction of the Standard resulted in a reduction in EFTPOS interchange fees of around $0.15 per purchase transaction, from around $0.20 paid to the acquirer prior to the reforms.

At the time that the interchange fees Standard for the EFTPOS system was introduced, the Bank also imposed a separate interchange fees Standard on the Visa Debit system (Visa Debit interchange fees Standard).^[3] Prior to the reforms, the interchange fees on Visa Debit transactions were around 0.95 per cent of the transaction value, paid to the issuer (the opposite direction to the flow of interchange fees in the EFTPOS system). The Visa Debit interchange fees Standard placed a cap of $0.12, paid to the issuer, on the weighted average of interchange fees paid in the Visa Debit system. The cap is based on the cost to the issuer of authorisation and processing of scheme card transactions.

The introduction of the interchange fees Standards in the two debit card systems resulted in not only a reduction in interchange fees in each system, but also a narrowing in the differential of fees between the systems; the interchange fee differential between the EFTPOS and the scheme debit systems was reduced to around $0.17 on a $100 transaction, down from around $1.15 prior to the Bank's reforms (Graph 1).

While the interchange fees Standard reduced the size of the interchange fee differential between EFTPOS and the scheme debit systems, the Board continued to be concerned that the remaining difference preserved a strong incentive for issuers to promote the use of scheme debit over EFTPOS. In essence, the underlying transaction for EFTPOS and scheme debit is identical from the perspective of the cardholder at the point of sale – for both transactions, the funds are drawn from the cardholder's deposit account. However, issuers at the time had an incentive to promote scheme debit because of the interchange fee revenue generated. One outcome of this could have been the decline of the EFTPOS system solely as a result of the difference in interchange fees (regardless of the services it offered) effectively shifting transactions from the lower-cost EFTPOS system to the higher-cost scheme debit systems.^[4]

The extent of the incentive to issuers was evident in the increased promotion of scheme debit cards by some issuers, beginning in the late 2000s. In addition to more active marketing, some issuers took steps to replace their customers' EFTPOS cards with ‘multi-function’ cards with both EFTPOS and scheme debit functionality, and encouraged customers to press the ‘credit’ button at the point of sale to process transactions through the scheme debit networks.^[5] Consequently, the share of debit card transactions processed through the MasterCard or Visa networks increased over this period (Graph 2).^[6]

Concerns regarding the ability of the bilateral EFTPOS system to respond to competition from scheme debit led the Board to push for the establishment of an EFTPOS scheme; EPAL was established in April 2009 (see discussion on changes to governance arrangements, below). Following this, the Bank varied its interchange fees Standard in 2009 to accommodate the possibility of EPAL setting a multilateral interchange fee for the EFTPOS system. The varied Standard (which is the current Standard) distinguishes between interchange fees agreed bilaterally – which remain constrained within a range of between $0.04 and $0.05, paid to the acquirer – and those set on a common multilateral basis by EPAL. Multilateral interchange fees under the Standard are subject to a weighted-average cap of $0.12 flowing to the issuer, in line with the Visa Debit interchange fees Standard.

EFTPOS Access Framework

One response to the Board's concerns regarding access to the EFTPOS system for new participants came from the industry, which developed an access code setting out a procedure for new entrants to negotiate and implement bilateral connections with existing EFTPOS participants. The Access Code, administered by the Australian Payments Clearing Association (APCA) on behalf of EFTPOS Access Australia Limited, sets out timeframes for agreement on access terms and provides a mechanism to resolve disputes over agreements not finalised within these timeframes.

The Bank's Access Regime, imposed in 2006, operates in conjunction with the industry Access Code by adding two main provisions. First, it places a cap on the amount that an existing participant can charge an entrant to establish a new connection. This cap is based on a survey of the cost of establishing a past connection, and is currently set at $87,776. The cap on connection charges prevents existing participants from charging unreasonably high connection fees, which may discourage new entrants.

Second, the Access Regime contains ‘no-discrimination’ provisions designed to prevent existing EFTPOS participants from using negotiations over interchange fees to frustrate access. These provisions require existing EFTPOS participants to offer interchange fee terms to new participants that are no less favourable than terms agreed with other existing participants. The no-discrimination provisions were written at the time that interchange fees flowed to the acquirer in the EFTPOS system. Hence, they specifically require that existing participants offer prospective acquirers an interchange fee no less than the lowest fee paid to an existing acquirer, and prevent existing acquirers from demanding that prospective issuers pay an interchange fee greater than the highest interchange fee they receive from an existing issuer.

Recent Industry Developments

As discussed, the current regulatory framework for the EFTPOS system was put in place at a time when governance of the system was largely based on bilateral agreements that determined interchange fees and connection arrangements between participants. While certain operational procedures and general standards for the exchange of EFTPOS (and ATM) transactions were set collectively by APCA in its Consumer Electronic Clearing System (CECS) Manual and Regulations, there was no central body responsible for: promoting the use of EFTPOS; making strategic decisions about the system, such as the development of new functionality; or adjusting pricing to better compete with the scheme debit systems.

The Board noted concerns about the bilateral governance of the EFTPOS system in the conclusions to its 2007/08 review of the payments system reforms.^[7] Specifically, the Board noted that bilateral governance made it difficult for the EFTPOS system to adapt to changing technology and the demands of end users, and to compete effectively with the scheme debit systems. The Board therefore advocated the establishment of an EFTPOS scheme that could play a coordinating role in promoting and making decisions in the interests of the system as a whole. The Board was of the view that an EFTPOS scheme would be best placed to strike a balance between the interests of merchants, issuers and cardholders, and would contribute to a more competitive environment for debit cards. The industry's response was the establishment of EPAL in April 2009.

EPAL is owned and funded by its fourteen member institutions, including two large merchants, with three seats on its board reserved for independent directors. It has put in place scheme rules to regulate the activities of its members, covering aspects of access and interchange fees, as well as technical operational and security rules. Since its establishment, EPAL has taken an active role in promoting the use of EFTPOS and has made a number of strategic decisions, including the decision to introduce a multilateral interchange fee schedule from October 2011.

The multilateral interchange fee schedule introduced by EPAL reverses the direction of interchange fees from previous bilateral arrangements on most purchase transactions. A multilateral interchange fee of $0.05 is paid from the acquirer to the issuer, compared with an interchange fee of between $0.04 and $0.05 paid to the acquirer under bilateral arrangements. However, the multilateral interchange fee schedule does not currently apply to all EFTPOS transactions. Where EPAL members do not opt-in to the multilateral schedule, existing bilateral agreements remain in place until they expire or are terminated. In addition, EPAL members may bilaterally agree to an interchange fee that is different from the multilateral schedule. There also remain participants in the EFTPOS system that are not members of EPAL; these participants are not directly bound by EPAL's Scheme Rules, including any multilateral interchange fee schedule set by EPAL.

Alongside the developments in governance arrangements for the EFTPOS system, there have been significant changes to the underlying architecture of the EFTPOS system. The industry, with encouragement from the Bank, has worked since 2009 on migrating to a COIN for the exchange of messages in bilateral payment systems. The COIN removes the need for participants to establish physical bilateral links to every other participant for messaging; instead, participants can establish a single physical connection to the COIN. By simplifying the physical connection process, the COIN has the potential to reduce the cost and shorten the timeframes involved for new EFTPOS entrants to establish connections to existing participants.

The Current Review

In response to these significant changes to the governance and underlying architecture of the EFTPOS system, the Board announced in September 2011 that it would undertake a review of the regulatory framework for the EFTPOS system. The aim of the review is to ensure that the regulations for the EFTPOS system continue to meet their objectives of promoting competition between the EFTPOS and scheme debit systems, improving efficiency in the payments system as a whole, and providing fair access to new participants.

As a first public step in this review, the Bank issued a consultation document on the designation of the EFTPOS system in March 2012. Changes to APCA rules (which were relied on to determine the scope of the original EFTPOS designation) along with the changed governance arrangements, mean that the original designation no longer clearly defines the EFTPOS system. The views expressed in consultation and the decision on the designation are discussed in the next section.

Footnotes

Reserve Bank of Australia and Australian Competition and Consumer Commission (2000), Debit and Credit Card Schemes in Australia: A Study of Interchange Fees and Access, October. [1]

This difference was between a $0.95 interchange fee paid to the issuer for a $100 scheme debit transaction, and an interchange fee of around $0.20 paid to the acquirer for an EFTPOS purchase transaction. [2]

MasterCard provided a written undertaking to the Bank to meet the same benchmark for the Debit MasterCard system (as well as a written undertaking to comply with a separate standard on the honour-all-cards rule and surcharging). [3]

The Bank undertook a study of the cost of different payment methods as part of its 2007/08 review of the payment system reforms. That study found that, for financial institutions, the resource cost (i.e. excluding transfers such as interchange fees) of an average EFTPOS transaction of $59 is around $0.22, while the resource cost of an average scheme debit card transaction of $81 is around $0.46. For merchants and consumers, the total resource cost was also estimated to be higher for a scheme debit card transaction than for an EFTPOS transaction. The scheme debit cost data should be viewed with some caution, however, because there were only a small number of responses on scheme debit costs; the study was undertaken prior to the increased promotion of scheme debit cards by the major banks. For further details, see Schwartz C, J Fabo, O Bailey and L Carter (2008), ‘Payment Costs in Australia’, in Payments System Review Conference, Proceedings of a Conference, Reserve Bank of Australia and Centre for Business and Public Policy at the Melbourne Business School, Sydney, 29 November 2007, pp 88–138. [4]

Most scheme debit cards on issue in Australia can be processed through either the EFTPOS system (the cardholder presses the ‘cheque’ or ‘savings’ button on the terminal) or one of the scheme debit (MasterCard or Visa) systems (the cardholder presses the ‘credit’ button on the terminal). [5]

The Bank began collecting separate data on scheme debit transactions from March 2008. [6]

Reserve Bank of Australia (2008), Reform of Australia's Payments System: Conclusions of the 2007/08 Review, September. [7]