On 17th December 2014, the European Commission announced that agreement had been reached on the proposed EU regulation of card interchange fees. If the draft regulation is formally adopted it will introduce maximum fees for consumer debit and credit cards, prevent Card Schemes from forcing retailers to accept all types of cards regardless of their associated fees, and establish transparent rules for all card transactions.
The changes would force Card Schemes such as Visa and MasterCard to reduce the interchange fees that can be applied to transactions. In the EU there are more than 40 billion card payments annually and so banks, card issuers, merchants and players are watching developments cautiously. However with the regulation yet to be formalised, and the debate continuing between those for and against, what impact could these changes have for the card industry in Europe?
The agreement reached by the Euro Parliament and Commission specifically proposes three key changes:
1. The introduction of limits on the charging of interchange fees for 4-party models
2. The removal of rules currently forcing merchants to accept any card type regardless of the fees as structured and controlled by Card Schemes
3. The establishment of transparent rules and standards for all transactions
Rationale for regulation
The EU wants to implement regulation as an anti-trust measure, with the aim of stimulating healthy market competition and innovation, proving beneficial for the customers on both ends of the value chain.
As it stands today the consumer ultimately meets the cost of interchange, with merchants factoring the expense into their pricing models. So under the propose regulation, cardholders should (in theory) benefit from merchants passing on savings to customers through lower prices. Some markets, such as the Netherlands, have successfully reduced interchange as a result of regulatory intervention, and consumers and retailers can now take advantage of cheaper online payment solutions that do not require subscription fees.
The proposed legislation includes those 3-party Card Schemes that operate like 4-party models by licensing their cards to other banks, closing one potential loophole for Card Issuers (although it stipulates a 3 year exemption). However American Express and Diners cards issued directly to customers will remain exempt, and equally corporate cards are not included in the draft regulation.
Some are worried it will not have the right effect
Despite the best intentions of the lawmakers, there are many who believe that the regulation will have a serious impact on existing business models.
Firstly, issuing banks would face reduced revenues and be forced to recoup this lost revenue elsewhere. Some point to recent experience in Spain and Australia, where there have been efforts to regulate interchange which has forced issuing banks to recover revenues by raising cardholder fees and narrowing the range of benefits offered with cards. Banks will only be successful when they are able to transfer less cost to the customer by subsidising through other products, internal efficiencies or innovation to improve the cost/value ratio.
Secondly, there are no guarantees that retailers would pass on reduced acquiring fees to customers in reduced pricing, with customers losing out if card fees are increased or benefits removed. Indeed many are pointing to significant risks that the proposed changes would negatively impact the balance of the two-sided card market. In a two-sided market model one user group sees increased ‘utility’ (i.e. incentive to participate) as the other group grows (and vice-versa). The proposed changes would reduce the value of participation in the marketplace for Card Issuers, and a consequent fall in user group size could see a vicious cycle where there is less and less incentive for issuers and consumers to engage in a card scheme. Nonetheless, there is the potential that this could present an opportunity for smaller issuers to compete in the absence of large interchange fees payable to issuing banks – could this drive innovation?
Critics of the proposed regulation also point to the fact that it specifically excludes 3-party card issuers such as American Express and Diners, as well as Corporate Card Issuers, who will therefore be able to continue to charge higher fees. Naturally these high fees will result in these issuers being able to afford stronger value propositions for their customers in the form of frequent flyer points, cashback or other value add services, potentially creating a two-tier card market. Customers may increasingly be forced to make a decision between cards which are accepted in a wider variety of merchants but which offer leaner value propositions, and those accepted in fewer retailers, but offering more valuable rewards.
What does all this mean for the card industry in the EU?
While the legislation has yet to be finalised, now is the moment for market participants to take action:
- There is uncertainty as to whether or not retailers will pass on savings in card fees to consumers, in real terms any reduction would be relatively small and unlikely to be more than 1% of any transaction
- Retailers may need to renegotiate contracts with the acquiring bank that provide their payment acceptance services to ensure that receive the benefits of reduced Interchange
- Retailers may wish to consider any Card Scheme relationships they hold directly (likely American Express or Diners) to ensure they are delivering value for money.
For Banks and Card Issuers:
- It remains to be seen how issuers would recoup a sudden drop in interchange revenues. Looking at previous experience, this cost will inevitably be passed onto the consumer through increased card fees and/or reduced card benefits.
- For banks that issue and acquire card transactions the balance between the two businesses will prove critical, as those with balanced businesses will be able to offset a decrease in issuing revenues with a saving on acquiring fees.
- For card acquiring businesses, there may be an expectation that pricing to retailers will be reduced, but this must be balanced against the cost of implementing such changes.
For Card Schemes:
- Card Schemes are left to rethink their business model due to the imminent restrictions on their ability to influence one of the most important value drivers of a successful platform business – pricing.
- In particular, Card Schemes will be working hard to ensure that new competitors that are able to enter the market as a result of the regulation do not disrupt their current business models. However despite these changes, it would take significant investment for any provider to match the scale of the current global providers.
- For 3-party Card Schemes such as American Express and Diners Club, there is an opportunity to stand out in the marketplace by offering a stronger value proposition than their competitors, given they do not face regulation to reduce their card fees.
For outsiders and innovators:
- With the regulation impacting the 4-party card model, there is the potential for industry newcomers to disrupt the landscape and challenge incumbent Card Schemes.
The card industry continues to provide an essential method of conducting quick, easy and safe transactions globally. While the impact of regulation on the largest Card Schemes is unlikely to do much to challenge the current market share of the dominant players, it is certainly a key moment for innovators.
Whatever the impact of regulation on the current market configuration, there are certainly enormous opportunities available for those who embrace the challenges these changes will bring.