Review of Card Payments Regulation

In brief

Written by Partner Karla Fraser and Associate Andrew Shetliffe

The level of public interest and popular support for regulation targeting excessive surcharging makes card payment regulation likely to be one of the first areas of reform following the publication of the Final Report of the Financial System Inquiry (the FSI Report).

On the back of recommendations made in the FSI Report, the Reserve Bank of Australia (RBA) released, in early March, an Issues Paper in relation to a Review of Card Payments Regulation. Consultation on the RBA Issues Paper closed on 24 April 2015.

Card payment fees

In a typical card transaction, an interchange fee is paid by the merchant's financial institution (the acquirer) to the cardholder's financial institution (the issuer). Interchange fees influence the levels of acceptance of different cards, as well as the relative costs faced by consumers and merchants, including by subsidising the costs to card issuers of offering rewards programs or other benefits to cardholders.

It is generally accepted that merchants have little choice but to accept payment by cards of major schemes. Interchange fees and merchant service fees increase the cost of doing business – and, in turn, the cost to consumers for the product in question.

Need for reform – interchange fees

Higher interchange fees allow card issuers to offer more generous programs. In an outcome described by the RBA as 'perverse',¹ competition between card schemes (and the offer of generous reward programs) can incentivise cardholders to use products with higher interchange fees.

Under the Payment Systems (Regulation) Act 1998 (the PSRA), the RBA has issued standards for interchange fees for Visa and MasterCard credit card schemes and the EFTPOS system that cap interchange fees: the weighted average of interchange fees (as calculated according to the standard) may not exceed the applicable RBA benchmark.

Card schemes claim that the benefit to consumers from the regulation of interchange fees is not evident. In its submission to the Financial System Inquiry, the Australian Payments Clearing Association acknowledged difficulty in demonstrating that savings to merchants have led to lower retail prices. Removal of interchange fee caps was in fact included as a policy option for consultation in the Interim Report of the Financial System Inquiry. However, this option was not endorsed by the FSI Report, and the RBA appears convinced that market forces will ultimately result in lower interchange fees being reflected in lower retail prices.

Need for reform – merchant surcharging

Surcharging refers to the fees charged by a merchant in connection with payment by card.

Under the PSRA, the RBA has issued standards that prohibit the rules of a regulated card scheme (Visa, MasterCard and EFTPOS) from preventing a merchant from recovering the merchant's 'reasonable cost' of accepting relevant cards by imposing a surcharge. Although not regulated by the RBA standards, American Express and Diners Club have given voluntary undertakings to the RBA not to include such restrictions in their scheme rules.

The current state of regulation is a reversal of the earlier position where the standards did not prohibit this, and, as a consequence, merchants (by virtue of the rules of the various card schemes, which provided that a merchant was not permitted to surcharge for payment by the relevant card) were required to absorb the cost of payments by card as a cost of doing business. (And often, in practice, resulted in a merchant not accepting payment by certain cards). 

The RBA's view is that the transparency achieved through merchant surcharging helps to keep interchange fees lower. For much the same reasons, consumer and industry groups, including CHOICE and the Australian Payments Clearing Association, have generally expressed support for permitting merchants to levy reasonable surcharges for particular payment methods. However, consumers have (including by way of some 5000 submissions to the Murray inquiry) expressed dissatisfaction with excessive surcharging by merchants for payments by card.

Consumer dissatisfaction in part appears to be a result of a lack of understanding and visibility in relation to a merchant's payment processing costs – resulting in consumers being unable to assess whether a surcharge is reasonable (and generally assuming that it is not). (The RBA also noted in its Issues Paper that merchants have difficulties in identifying the costs of different cards and that such difficulties are compounded by the ever-widening range of different interchange rates.)

That the RBA, however, does not regulate merchants (ie businesses), and cannot prescribe what a merchant charges its customers, is a nuance that has been missed by the public at large. When reforms were made to the payments system in early 2013 to prescribe that merchants could not be prohibited from surcharging their 'reasonable costs of acceptance', this reform was largely misinterpreted by consumers and consumer and industry groups as the introduction of a positive obligation on merchants to only charge their 'reasonable costs of acceptance'. The reform did no such thing.

Proposed reform

The FSI Report recommended (i) lower interchange fees (and improved interchange fee regulation by clarifying thresholds for when they apply, and broaden the range of fees and payments to which they apply), and (ii) imposing more prescriptive surcharging regulation to expand its application and ensure customers using lower-cost payment methods cannot be over-surcharged.

In response, the RBA has put forward some options:

Interchange fee regulation

• broadening interchange fee caps to include other payments between schemes and issuers that currently circumvent interchange caps.
• changing the interchange benchmark system to reduce the upward ‘drift’ in average interchange rates inherent in the current three-year reset cycle.
• replacing weighted-average interchange caps with hard caps.
• allowing for ‘buying groups’ for smaller merchants to group together (subject to competition law restrictions) to negotiate to receive the lower interchange rates that are accessible to larger merchants.

Merchant surcharging regulation

• a three-tiered system (also endorsed by the FSI Report):
  • allowing low-cost system providers to prevent merchants from surcharging, to encourage consumers to use low-cost payment methods.
  • allowing medium-cost providers to limit surcharges to limits set by the RBA.
  • allowing high-cost providers to limit surcharges to the reasonable cost of acceptance, but requiring these providers to disclose that they are high-cost providers so that customers would understand why they are surcharged.
• targeted regulation to reduce particular cases of excessive surcharging (in particular in relation to the airline and taxi industries).
• changes to enforcement procedures and disclosure practices, to ensure disclosure of surcharges to customers before payment and requiring that there be at least one non-surcharged method of payment.
• controls on scheme rules or contractual terms that prevent merchants from informing consumers about the cost of interchange fees or merchant service charges as a way of facilitating differential surcharging by merchants.

Where to from here?

Reform in this area has the look and feel of a 'vote winner', which will no doubt enlarge the target on its back. Whether the large payment schemes have enough clout to resist reform or curtail the extent of the reform remains to be seen. If any one thing is certain (like death and taxes), it is unlikely consumers will see a lower retail cost of goods in the near future – the cost to merchants of implementing any reform (such as determining the reasonable cost to it of acceptance of each type of card) may well outweigh the saving.