An American Fortress

Durbin Amendment aside, American payment cards have mostly escaped the type of regulation affecting cards in other countries. Can that last?

The United States is increasingly becoming an island in a widening sea of payment card regulation.

Just last month, Canada’s federal government updated its 5-year-old Code of Conduct for the payments industry. In addition to requiring merchant acquirers to pass through recent Visa Inc. and MasterCard Inc. interchange reductions to merchants, the update gives merchants more freedoms in their contracts with acquirers and requires processors to make more disclosures to merchants.

Canada’s action followed by only a month the European Union’s approval of major cuts in Visa and MasterCard interchange fees. Those cuts could reduce merchants’ card-acceptance costs by 6 billion euros ($6.4 billion) annually, according to the United Kingdom’s BBC news service.

A 2014 survey by the Federal Reserve Bank of Kansas City documented 38 countries where public authorities intervened in or began investigations of payment card networks’ interchange or merchant-service fees. A few such actions began in the 1990s, but most started in the 21st Century, with seven beginning in 2010 or later.

Governments also intervened in or launched investigations of no-surcharge and non-discrimination rules in 36 countries, according to the survey. All but eight of those investigations have begun since 2005.

“We’ve definitely been seeing a lot more of this activity,” says Kevin Hodges, chief financial officer of EVO Payments International, a big merchant processor based in Melville, N.Y., that also operates in Canada and Europe.

‘A Grueling Battle’

All of this activity prompts the question: is the U.S. acquiring industry headed for more regulation?

The answer from payments-industry insiders is: Probably not, if regulation is defined as new legislation from Congress.

Congress’s major intervention into the card market to date came through the Durbin Amendment in 2010’s Dodd-Frank Act. The Federal Reserve Board’s rule implementing the amendment imposed a debit card interchange price cap that cut big issuers’ interchange income by about 50%. The amendment also created debit card transaction-routing requirements intended to give merchants more choice among debit networks.

No such specific regulations exist for credit cards, though credit card issuers are subject to existing banking and consumer-protection rules.

Dodd-Frank was Congress’s sweeping answer to the financial meltdown of 2008. U.S. Sen. Richard Durbin, D-Ill., then the Senate’s No. 2 Democrat, deftly attached his merchant-friendly debit proposal to the main bill, which had virtually nothing to do with cards. The amendment survived furious attempts by the weakened banking lobby to excise it.

The political landscape has changed greatly since Congress passed Dodd-Frank. Employment, the mortgage market, and the general economy have recovered, though not nearly as much as many observers would like.

“The conditions that were present for the Durbin Amendment were kind of unique and unusual and hard to replicate,” says C. Marc Abbey, managing director of Annapolis, Md.-based First Annapolis Consulting Inc., which works closely with acquirers and other payments companies.

Scott Talbott, senior vice president of government affairs at the Washington, D.C.-based Electronic Transactions Association, the leading acquiring-industry trade group, says “the [Durbin] interchange effort was a grueling battle that forced members of Congress to choose between two constituents—i.e., financial institutions and merchants, and they don’t want to do that again.”

A renewed tussle over cards is probably even more unlikely because Republicans, usually perceived to be more business-friendly than Democrats, gained a majority in the Senate after the 2014 elections, giving the GOP control of both Houses of Congress.

The States’ Crusade

But Republican control of Capitol Hill doesn’t mean that a return to laissez-faire is in the cards for the card industry. The regulatory and antitrust arms of the executive branch have plenty of initiatives already going to bring various parts of the payments industry to heel.

For example, the Consumer Financial Protection Bureau, another creation of Dodd-Frank, has been particularly active in 2015 regarding payments.

In a federal lawsuit filed last month against a group of allegedly fraudulent debt-collection companies and their owners, the CFPB also named as defendants the big merchant processor Global Payments Inc. and three independent sales organizations for their role in providing payment services to the debt collectors.

Observers likened the CFPB’s tactics to the controversial Operation Choke Point, in which the U.S. Department of Justice and other federal agencies have tried to stop allegedly fraudulent merchants by going after the processors that enable such merchants to accept electronic payments.

In the process, critics said, the government tried to deny payments services to entire categories of legal but sometimes controversial industries (“The CFPB’s Own Choke Point Gambit,” this issue).

PayPal Inc. also recently reported that the CFPB might sue it over its credit products. And the CFPB has proposed sweeping regulations on prepaid cards.

On the antitrust side, American Express Co. is likely to appeal a federal judge’s ruling in a case filed by the U.S. Department of Justice alleging that the card company’s rules against merchants steering AmEx cardholders to cheaper forms of payment are anti-competitive (“The Centurion’s Dented Helmet,” April).

Meanwhile, many states see the acquiring industry as worthy of some oversight, even though the interstate nature of the business leaves most regulation in the hands of federal agencies. At least 17 states ban credit card surcharging, according to the ETA.

One of the more recent state-level ideas is to exempt merchants from paying interchange on the state and local tax portion of payment card sales. Bills to such effect have been proposed in Colorado, Nebraska, and Arkansas, but the Colorado bill was killed in the state’s House of Representatives. The Arkansas and Nebraska proposals were still alive as of mid-April. How far these proposals might go is unclear, but the potential for card-pricing regulations in states never seems to go away.

“It’s safe to say the effort to try to affect the current level of interchange has moved from Washington to the states,” says the ETA’s Talbott.

Canada’s Code

Perhaps the longer-term concern for the U.S. acquiring industry is that the regulatory ideas that have made headway in Canada, Europe, Australia, and some Asian countries some day will be written into U.S. statute books or administrative rules.

Canada with its payment-industry Code of Conduct is of particular interest because of the country’s proximity to the U.S. Like American merchants, Canadian retailers have been complaining about rising card-acceptance costs. And they’re finding sympathetic ears in Ottawa.

The update to the conduct code announced in April adds consumer protections, addresses the growth of mobile payments and premium cards, and makes other changes intended to give merchants more information about and control over their payment-card acceptance costs.

The changes came after government officials conferred with retailers, small businesses, payment card networks, and merchant acquirers, Canada’s Department of Finance said.

A key change requires merchant acquirers to fully pass through to merchants the interchange reductions Visa Inc. and MasterCard Inc. announced last November. If they don’t, merchants can cancel their acceptance contracts without penalty. Those reductions will bring average card-acceptance fees down to about 1.5% of the sale, according to the Toronto Globe and Mail.

Canadian merchants have decried what they see as increasing interchange costs in recent years as banks began issuing higher-cost premium credit cards and major-brand debit cards.

Other changes will impose new premium card branding requirements on issuers so that merchants can more easily identify such cards at the point of sale. Issuers also must inform cardholders about the costs premium cards may impose on merchants.

Much of the update extends the Code’s reach to mobile payments and includes new consumer protections. For example, consumers are to have full control over the default settings of mobile wallets.

The revised Code will allow debit and credit functions to reside in the same mobile wallet, “provided that they are clearly separate payment applets, and consumers can select which payment applet shall be used for contactless payments,” the new language says.

Other new provisions include a complaints-handling process for Code-related issues; enhanced acquirer disclosures through plain-language statements of key contract terms, conditions, and merchant fees in summary boxes on merchant contracts; greater flexibility for merchants to exit their contracts without penalty; and limitations on the automatic renewal of merchant contracts.

‘A Clever Approach’

The Retail Council of Canada and the Canadian Federation of Independent Businesses praised the revisions, according to the Globe and Mail. Another trade group, the 98,000-member Small Business Matters Coalition, said it welcomed the updated rules but that Visa and MasterCard fees are still too high.

The Code originally was described as voluntary, though the government’s clear expectation in 2010 was that networks, acquirers, and issuers would abide by it.

Abbey of First Annapolis says the Canadian government has taken “a clever regulatory approach” with the Code by avoiding the overt price controls other nations have embraced.

“The philosophy underlying the Code of Conduct is to level the playing field, to provide information to merchants that they can [use to] make good decisions,” he says.

Could such a code be implemented in the U.S.? Probably not, according to Abbey, because, unlike Canada, the U.S. lacks a highly concentrated financial sector amenable to making deals with the government. But, regarding “the underling philosophy, there is some analogous thinking,” he adds.

‘A Different Environment’

Price controls are the order of the day in Europe. The European Parliament in March lent its support to a plan by the European Commission, the European Union’s executive arm, to cap MasterCard and Visa interchange at 0.3% of the sale for credit cards and 0.2% for debit cards. Current interchange rates vary widely by country, with credit card interchange averaging 1.8% in Germany and debit interchange averaging 1.6% in Poland, according to press reports.

The hope is that in addition to cutting merchants’ card-acceptance costs by 6 billion euros, the regulation will let consumers enjoy pass-through savings on goods and services of an estimated 730 million euros ($784 million), according to the BBC.

Such a drastic mandated reduction in interchange is highly unlikely to happen in the U.S., at least in the near term.

“I think probably not,” says EVO’s Hodges. “In Europe, payments tend to be thought of kind of as a utility. It’s just a very different environment here in the States.”

Of course, merchants welcome any reduction in interchange costs. U.S. retailers battled the Fed’s Durbin rule all the way to the Supreme Court, which in January refused to hear their appeal that the price cap, while significant, didn’t reflect Congress’s full intent and set debit interchange too high.

Acquirers, too, can benefit from interchange price controls. They’re the ones to which the networks assess interchange, and usually they don’t have to pass on any reductions to merchants through their discount rates. Thus, interchange cuts enable acquirers to pad their profit margins.

That happened for a while in the U.S. after the Fed’s Durbin rule took effect in late 2011, until competition eventually eroded the enhanced margins. The same could happen in Europe once the EU’s reductions are fully in place. Top executives of Atlanta-based Global Payments, which has major operations in Europe, told analysts April 8 that they expect the company’s international margins to benefit initially from the interchange cuts.

Litigation to Regulation

While heavy-handed interchange price controls don’t seem to be in the cards, the long-term outlook in the U.S. may be for more regulation from banking and consumer-protection agencies as opposed to antitrust measures such as those brought by the Justice Department.

The regulation review by the Kansas City Fed said the worldwide trend is moving away from litigation and toward regulation to correct perceived problems.

The reasons, according to senior economist and report co-author Fumiko Hayashi, are the long times required for litigation, the uncertainty for industry participants that litigation creates, and the relative inflexibility of litigation compared with the tools bona fide regulators have to create structural reforms and evaluate interchange, surcharge fees, and related revenue streams in the wider context.

“Regulation can bring much broader scope … than litigation,” Hayashi tells Digital Transactions.

So while the acquiring industry has little to fear from Congress at the moment, it probably would be wise to keep an eye on what’s going on abroad regarding regulation. Ideas, after all, are not subject to import controls.

Recent Worldwide Trends in Acquiring-Related Government Activity

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• Interchange and merchant-service fees

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• Market interventions or investigations launched in 38 countries, seven since 2010.

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• More interchange interventions are arising from legislation and regulatory-agency actions as opposed to court decisions and antitrust settlements. Central banks in China and Australia began regulating interchange and merchant fees in the early 2000s; four more central banks joined them in the late 2000s or afterward.

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• Surcharges/merchant anti-discrimination rules

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• Interventions or investigations in 36 countries, all but eight since 2005.

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Note: Based on review of regulations, antitrust activity, and other litigation, with some actions starting in the 1990s but most since 2000. Source: Federal Reserve Bank of Kansas City