The payments industry has been hitting the headlines recently. A wave of takeovers including Mastercard and Nets, Visa and Plaid, Worldline and Ingenico, Nexi and Nets have caught much attention. But it’s not just businesses making the news. A number of regulatory reviews have caught the whole industry’s attention, including HM Treasury’s Payments Landscape Review, the Independent Fintech Strategic Review led by Ron Kalifa, the EU report on the effectiveness of the Interchange Fees Regulation (IFR) and the Payment System Regulator’s (PSR) ongoing work to implement the New Payments Architecture. In September the UK’s Payment System Regulator (PSR) published its interim report of the Card Acquiring market review. This review focuses on whether savings from the cap introduced in the Interchange Fee Regulation (IFR) have been passed on to merchants.
Card scheme fees have doubled: is that even an issue?
The PSR gathered data on how fees that acquirers collect from retailers for Mastercard and Visa have changed between 2014 and 2018.
The data shows fees have roughly doubled when taking into account account volume growth and changes in transaction mix over the 4 year period.
In an easy to miss footnote, the PSR notes that “In line with our final Terms of Reference, we have not reviewed whether these fees are excessive”. So, what happens next? Will the PSR take this any further? Without further investigation the PSR won’t be able to assess if the fee increases go against the regulator’s statutory objectives and herein lies the big question.
Price increases can, in some situations, be perfectly legitimate. For example, when they bring benefits for merchants or the card holding consumers through investments in the form of improved cyber security, improved infrastructure, or rewards for digital innovation. Higher scheme fees can also reflect increased regulatory compliance costs, or a shift in responsibilities from issuers to scheme operators.
However, more sinister explanations might be at play. The fee increases may indicate that payment scheme operators enjoy significant market power. If so, this comes at the expense of merchants (i.e. retailers) and consumers, which goes against the PSR’s statutory objectives.
So where will the PSR go from here?
As the PSR has concurrent competition powers with the Competition and Markets Authority (CMA) in relation to participation in payment systems, it could decide to independently pursue one of a range of initiatives. Alternatively, it could launch a joint initiative with the CMA(1) or let the CMA take the lead altogether. The potential outcomes of any next steps would not be materially affected by which agency takes the lead, as the two agencies have similar competition powers. For this reason, below we refer only to the PSR for simplicity.
A fairly aggressive route would be to initiate a competition enforcement action against Visa and/or Mastercard. One course of action might be to launch an “excessive pricing” case. Past cases show that even experienced competition authorities, such as the CMA with its recent wave of pharmaceutical cases, often struggle to demonstrate what is deemed ‘excessive’ in court, let alone a relatively new regulator with just one case under its belt. With this in mind an excessive pricing case is most unlikely.
The PSR may instead argue that such price hikes have “exclusionary effects”: that is, in two-sided markets such as card schemes, high prices charged to one side (merchants) can be used to deter entry or expansion on the other side, that is, to incentivise banks to stick to card schemes, and in doing so, effectively limit the opportunity for efficient competitors to move in.
A legal case for such an abuse of dominance against these well-funded companies would present a herculean-sized challenge. The PSR is painfully aware of the looming issues and recently scaled back its analysis of profitability in the Card Acquiring Market Review. Does it have the appetite, the data or capability to embark on a more complex profitability and cost analysis? Might the PSR consider that these investigations and appeals take too long to conclude, before any benefit accrue to users of card payments?
A more likely route is for the PSR to launch a market review on scheme fees or scheme rules. Past market reviews or studies have been triggered by much lower annual price increases, especially when the sector is seen as essential, consumers are potentially vulnerable and there’s lots of political interest. These are three boxes that card payments certainly tick during a global pandemic(2).
What would PSR action mean for UK card schemes?
Any market review, with or without the CMA, may highlight concerns around market power and if so the PSR will have to decide how to tackle these . There are two main approaches here:
- One is price regulation. The PSR has the power to set a cap to the level of scheme fees, effectively widening the scope of the IFR cap to include scheme fees. Retail price controls have experienced a resurgence in recent years, but have been criticised as counter-productive in the long term, and prone to gaming by regulated companies.
- A second is a package of remedies to encourage effective competition. The PSR interventions would aim to (i) revive competition not just between the schemes, but also across payment rails (such as interbank payments or Payment Initiation Services) and (ii) encourage entry and innovation in payments.
An ambitious PSR may decide that encouraging effective competition is preferable to price regulation in the longer term. But it’s not going to be straightforward. The PSR would have to design a framework that provides the right incentives to consumers, merchants, issuer banks, card scheme operators and other competitors.
We might see glimpses of the PSR’s emerging thinking around its goals, lines of inquiry and remedy options in two blog posts that introduced the ongoing “Competition” theme in its strategy work:
- The PSR Chief Economist Matthew Cherry reminds us that “competition is not an end in itself but something which delivers good outcomes for - in our case - those making and receiving payments.”
- Technical Specialist James Jamieson reminds us that, for competition in card payments to work:
- Merchants should see payment methods as substitutes rather than complements, and
- Those making choices should directly bear the cost of their decisions, which may not be happening as regulation - the EU IFR and the UK Payment Services Regulations 2017 (PSRs2017)(3) - artificially suppresses price signals faced by issuer banks and consumers.
Brexit could create an opportunity for the PSR to call for big change, a radical redesign of the regulatory framework that applies to card payments. What could that look like? The answer would very much depend on market review findings, and the PSR’s willingness to pursue “tough sells” politically.
But, it may conclude that the IFR does not go far enough and call for a ban on interchange fees (or equivalent payments to issuers) - like the Australian Productivity Commission did in 2018(4); and it may make the case for a review of the PSRs 2017 so as to reintroduce the possibility of surcharging.
Whichever route the PSR favours - ex-ante price regulation (a cap on scheme fees) or promoting effective competition on the back of price signals - it feels like a big moment for the card scheme operators. All routes open to the PSR signal complex challenges ahead. So what could those facing the looming issues do now to get ready?
For starters, card scheme operators can set out a pro-competitive narrative to explain the doubling of scheme fees identified by the PSR. Clear and consistent articulation of the narrative, supported by robust evidence, can have a significant bearing on the outcome of any dealings with the regulator. Together, these go a long way to build the credibility of the business, protect the brand and act as an ‘insurance policy’ against potential future complications.
Beyond this, card scheme operators can engage with the PSR to help shape the post-Brexit regulatory environment they want to operate in and - most importantly from a regulator point of view - that can deliver material benefits to UK payers and payees.
(1) For example, between 2010 and 2014 Ofgem, the Office of Fair Trading and the Competition Commission (predecessors of the CMA) worked jointly on the Retail Market Review, which eventually led to the Retail Energy Market Investigation Reference.
(2) See for example the CMA’s statement of scope for the funerals and cremation services market study.
(3) The PSRs 2017 implement the EU Payment Services Directive (PSD2). The latter prevents surcharging for consumer cards albeit in the UK the PSRs 2017 went even further by banning surcharging across payments.
(4) See Recommendation 17.1 in its June 2018 Inquiry report on Competition in the Australian Financial System