Acquiring: Europe’s Card-Fee Conundrum

Karen Epper Hoffman

A new proposal from European regulators promises dramatic cuts in interchange revenue. Will these rules encourage even more stringent measures in the States?

The United States often looks to Europe for trends in fashion, environmental sustainability, and other concerns. Now the issue is payment card expenses and revenues.

Big cuts in credit and debit card interchange could be coming in the European Union, raising questions about the future of payments there and well as whether the U.S. might follow suit.

In late July, the EU’s antitrust authority, the European Commission, proposed sweeping new interchange price controls that would effectively cut merchants’ debit card acceptance costs to 0.2% of the sale and credit card acceptance to 0.3%—a mighty drop from current interchange fees, which can run as high as 1.6% on credit card transactions in Germany, for example.

Overall, the plan would cut card issuers’ current interchange revenues by more than 30% for debit cards and 40% for credit cards.

The 28-nation EU’s payments market—where MasterCard Inc. and Visa Europe, a bank-owned licensee of San Francisco-based Visa Inc., dominate—is valued at €130 billion per year, or $172 billion. Many but not all EU countries use the common euro currency.

The EC’s so-called Payment Service Directive also calls for the legal separation of the ownership of card networks (often dubbed “schemes” in Europe) and payment card processors. In addition, the proposal would limit the networks’ honor-all-cards rules and related rules preventing merchants from steering customers to other payment forms, and require merchant acquirers to disclose to merchants the fees they pay each month by type of card and card brand.

Merchants could not be barred from disclosing to customers how much they pay in acceptance fees. Merchants, however, no longer would be able to surcharge card transactions.

‘Excluding Three-Party Networks’

The EC said one key reason for its proposal is that competition among so-called four-party payment systems such as the Visa and MasterCard networks consists largely of trying to convince issuers to produce as many cards with their brands as possible by raising interchange rates. That increases merchants’ expenses and ultimately consumer prices, the EC said.

It could take a while for the European Parliament and a majority of EU member states to approve the proposal. Assuming the plan passes, observers believe the caps might take effect as early as late 2014. The caps on so-called multilateral interchange fees, or MIFs, would apply only to cross-border transactions in their first two years, after which they would be extended to domestic transactions.

The plan seemingly would most affect countries such as Luxembourg, the United Kingdom, and the Netherlands, where payment card penetration is most advanced, and countries in Eastern Europe the least.

Not surprisingly merchants by and large are hailing the proposal, which has been long-expected by most industry observers given the Commission’s more than 30 investigations of interchange in the past 15 years. But the banking industry and its supporters are much less enthused, to say the least.

In interviews with the European press, Peter Ayliffe, president and chief executive of Visa Europe, complained that the proposals largely exempted American Express Co. as well as many e-commerce and mobile-payments service providers.

(AmEx is largely a “three-party” network that issues most of its branded cards and acquires its own transactions; less than 9% of the fees charged by AmEx would be affected by the EC proposal as most of its payments do not involve interchange.)

“Payment cards provide huge benefits to consumers, retailers, and the economy as a whole and we are concerned that these proposals will be detrimental to the innovation that will support European economic growth,” Ayliffe says in an e-mail to Digital Transactions. “There is little evidence to support the claims that these proposals will be beneficial to consumers.

“We recognize the Commission’s steps towards creating a level playing field for all current and future payment market participants, but we believe they have fallen short of this goal by largely excluding three-party schemes such as American Express, non-card e- and m-commerce payment solutions, and primarily focusing on four-party card systems like Visa Europe,” Ayliffe continues.

“Further analysis of the detail of the documents is now needed and we will continue to engage with the Commission, the European Parliament, and member states during the legislative process to ensure the interests of European consumers and all stakeholders are properly represented,” Ayliffe says.

MasterCard Europe expressed similar concerns in its response, issued July 24, on the heels of the official proposal.

“While we support the Commission’s goals, we are concerned that some of the legislative proposals introduced today, such as the caps on interchange fees and restrictions on the honor-all-cards rule, do not support these goals and will actually harm and inconvenience consumers and small merchants, as well as hinder competition and innovation in the European payments landscape,” said Javier Perez, president of MasterCard Europe.

MasterCard sponsored a study by Europe Economics that estimated that card-issuing British banks alone earn £2.3 billion ($3.5 billion) in interchange fees each year. The EC proposal reportedly would slash those revenues by £1.1 billion.

Payments As a ‘Utility’

Sébastien de Brouwer, executive director in charge of retail, legal, economic, and social policy for the European Banking Federation, a trade group, believes that while the EC’s regulatory intervention has been years in the making, it is not a favorable outcome. Interchange already is the subject of disputes in European courts, he notes.

“Court proceedings are ongoing, so it would perhaps have been better to leave this issue in the hands of competition authorities or at least wait for the outcome of these important ongoing cases,” he says. “Others might argue that such a proposal would at least bring more certainty.”

Payments researcher Zilvinas Bareisis, a senior analyst at Celent LLC’s London office, says, “I don’t think it’s a positive. I’m a big believer in being reimbursed appropriately for what you do.”

And as for the EC’s goal of putting more money in consumers’ pockets by cutting merchants’ card-acceptance costs, Bareisis, like many other industry observers, doesn’t buy it.

“I don’t believe that retailers will pass the cost savings to consumers. There is no evidence that that has happened” in countries such as Australia that have set strict controls on card costs, he says. “There is the positive that interchange hasn’t been banned outright, which was a possibility.”

Some U.S. consultants echo the concerns of the Visa and MasterCard European leaders, as well as their financial industry-leaning colleagues overseas.

“It’s another step toward treating card payments as a public utility,” says Eric Grover, partner at Intrepid Ventures, a financial and payments consulting firm based in Minden, Nev. “Price controls are always a negative, they always have bad consequences. There is no realm of economics where that is not true. The European Commission wants to push down the cost of the transaction at the point of sale, but they’re not concerned with the payments landscape.”

William Keenan, chief executive of Wilmington, Del.-based DeNovo Corp., which works with payments-industry clients in the U.S., Canada, and Europe, says he is likewise “very much a believer in the free markets’ part in price.”

Keenan believes the Commission’s reasoning for setting the new low price controls—fear that the two major card networks were becoming too much of an oligopoly—is as flawed as the similar assessments about Microsoft Corp. in the 1990s. With new payments services emerging every day, he believes the interchange hit will hurt banks and card networks at a time when they already face growing competition.

‘Much More Harmonized’

Of course, the retail industry and its supporters have a different take on the EC matter: They believe it will indeed lower costs for merchants, and ultimately consumers, and increase payments competition.

Christian Verschueren, director-general of EuroCommerce, an industry group that represents national retail associations and some giant chains, including Carrefour, Ikea and Tesco, believes that the proposal will go a long way to set right the “uncompetitive markets we have had to live with where fees were set through Visa and MasterCard by the banks … These two companies have prevented new entrants from coming into the market.”

He adds: “We feel that with a 100-euro transaction or a 100,000-euro transaction, the amount of work is about the same.”

Similarly, retail partisans envision a rosier picture should the proposal pass.

“We expect to see a much more open and competitive market, with more entrants coming into it, with mobile commerce coming and new payment-service providers, with much clearer rules … Much more harmonized for everyone across Europe,” Verschueren says. “We still believe there’s money to be made by European banks.”

De Brouwer, who represents European banks, doesn’t quite see it that way.

“Most of the card-payment schemes in Europe have been developed via a merchant-based fee system. So imposing a cap on the [multilateral interchange fees] not only regulates price, but further risks inverting the existing models to one which will mean more costs for the consumer,” he says. “We are not convinced that this is what authorities are aiming for or indeed that it is in the interest of consumers. Excessively lowering MIFs would in our view, therefore, threaten innovation and security.”

Celent’s Bareisis also believes that payments innovation could suffer.

“If and when this happens, it will have major repercussions to the industry,” he wrote on Celent’s banking blog. “The banks will have to seriously question the viability of offering credit cards, are likely to be more open to experimenting with non-card-based solutions (e.g. bank account), yet the merchants’ incentives to accept anything other than cards and card-based solutions would be seriously diminished, dampening the prospects of innovation and startups.”

Scott Strumello, a senior analyst at New York’s Auriemma Consulting Group, which works with card issuers in the U.S. and Europe, doesn’t believe that consumers will be helped by the EC’s plan. He points to a November 2009 Government Accountability Office report tellingly titled, “Rising Interchange Fees Have Increased Costs for Merchants, but Options for Reducing Fees Pose Challenges.”

Guidance for the U.S.?

But could the EC’s proposal have an impact in the United States, which has already seen debit card interchange fees slashed with the Durbin Amendment, a part of 2010’s Dodd-Frank Act? In implementing the amendment, the Federal Reserve Board two years ago capped debit card interchange at between 21 and 24 cents per transaction for issuers with more than $10 billion in assets, essentially cutting regulated issuers’ interchange revenues in half.

Now, U.S. Sen. Richard Durbin, D-Ill., the controversial amendment’s chief sponsor, wants the Fed to look at the EC’s proposal for guidance in further lowering fees Stateside.

In the wake of the EC’s announcement, a new wrinkle hit U.S. debit interchange when U.S. District Judge Richard J. Leon threw out the Fed’s debit interchange cap. Leon said the cap was higher than Congress intended. Merchants hailed the ruling but the Fed is appealing it.

Leon also said the Fed’s rule implementing the debit transaction-routing requirements in the Durbin Amendment did not give merchants the panoply of choices Congress intended. The law intended merchant routing choice to increase network competition and thus hold down merchant fees.

But transaction routing, even under the Fed’s current, supposedly simpler, rule, is a sticky issue from an operational standpoint because of technical problems in adapting the routing systems to the coming Europay-MasterCard-Visa (EMV) chip cards.

The transition includes dates  on which liability for fraudulent transactions will shift to the non-EMV-enabled party, be it merchant or issuer.

As Bareisis pointed out in his Aug. 9 blog post: “The judge’s decision also appears to impose more routing requirements than the Fed’s ruling did, which even in the original implementation turned out to be a big stumbling block for EMV. What will this latest turn of events do for EMV prospects in the U.S.? If there is one thing certain it is that it will only create more uncertainty for the industry, making the original dates for the liability shift even more difficult to achieve.”

Bareisis concludes: “If the EC proposal guarantees anything, it’s that this debate is not going away. It gives fuel to the anti-interchange debate.”

What the European Commission’s Plan Would Do

Cut debit card interchange to 0.2% of the sale and credit interchange to 0.3%.

Limit honor-all-cards rules and rules restricting merchant steering of customers to preferred payment forms.

Require acquirers to disclose fees to merchants by card type and brand.

Enable merchants to disclose their card-acceptance costs.

End merchants’ ability to surcharge transactions.

Source: European Commission