The Payment Services Regulator (PSR) is consulting on its draft guidance (Draft Guidance, here) on the first phase of the EU Interchange Fee Regulation (Regulation). The deadline for responses to this consultation is 29 January 2016.
The Regulation, which came into force on 9 December 2015, capped interchange fees; a charge calculated as a percentage of the value of a transaction made using a payment card, which is paid by the merchant’s bank (the acquirer bank) to the cardholder’s bank (the issuer bank). The level of interchange fee is set by the payment card scheme (Scheme).
The European Commission (Commission) described interchange fees as “fees set by banks and payment card schemes, which are hidden from the consumer and neither the consumer nor merchants can influence”. It estimated that £1 billion of interchange fees were paid each year in the UK, prior to introducing the cap.
Phase two of the Regulation, which covers the separation of Schemes and processing entities, co-badging and branding, unblending and the “Honour All Cards” rule, will enter into force on 9 June 2016.
How does the Regulation limit interchange fees?
Under the Regulation domestic and cross-border (within the EU) interchange fees were limited to a maximum of 0.2% for debit card transactions and 0.3% for credit card transactions from 9 December 2015.
To support Schemes that offer a lower fee to encourage the use of innovative payment technologies (such as contactless), the UK exercised its national derogation to apply transitional capping provisions to domestic debit card transactions until 9 December 2020. Under these, interchange fees may be charged at any of: (1) the default option of 0.2% of each transaction’s value; (2) a weighted average of no more than 0.2% of the annual average transaction value of all domestic debit card transactions within that Scheme (e.g. non-secure transactions could be charge at a higher fee than 0.2% with low value transactions having a lower fee, which averages 0.2% of the total transaction value across the year); or (3) either a weighted average or flat fee lower than the default 0.2% per transaction.
Exemptions to the cap
The interchange fee cap does not apply to most commercial payment cards (i.e. company cards), cards which can be used only with one retailer or to purchase a limited range of products (e.g. store or fuel purchase cards), or cash withdrawals from ATMs.
Three party schemes
Three party schemes, under which the transaction travels between the Scheme’s acquiring and issuing arm (rather than separate banks), are exempt from the Regulation. However, where a three party scheme operates with licensee issuer and/or acquirer banks or issues co-branded cards, it is likely to be considered a four party scheme. Under the UK’s transitional provisions, three party schemes which are considered four party schemes will also be exempt from the cap on domestic interchange fees until 9 December 2018, provided that their market share does not exceed 3%.
In December 2015, the PSR published its provisional assessment of which three party schemes could benefit from the exemption (here). It determined that American Express operates the only potentially eligible three party scheme. However it is not exempt from the interchange fee cap as its market share exceeds the 3% threshold. The PSR will publish its final determination on exempt three party schemes later this year.
What is the impact of the Regulation?
It is estimated that the interchange fee cap will save merchants £480 million per year (British Retail Consortium) and businesses across all sectors an annual £700 million (UK Cards Association). As this represents lost revenues for banks, HM Treasury’s consultation response (Response, here) noted respondents’ concerns that banks may look at other sources of revenue to offset losses resulting from the cap. However, the Response determined that this risk will be combated by the Regulation’s requirement for transparent merchant service charges and wide circumvention prohibition, along with compliance monitoring by the PSR. The Commission will review the Regulation before 9 June 2019 to ensure that savings made by merchants are being passed onto consumers. Some consumers have been negatively affected in the short term by the interchange fee cap as some issuers, including Capital One and Royal Bank of Scotland, have chosen to withdraw cashback credit card products due to the introduction of the interchange fee cap and resulting revenue loss.
Commentators have suggested that narrowing the fee gap between debit and credit cards may lead to increased take up of credit cards across the European Union.
Some Schemes offer advisory and consultancy services, which leverage the data available to them to assist merchants and issuers in understanding spending patterns, maximising card usage and devising marketing strategy. Where services are paid for, offset against fees or offered as an incentive or rebate received by the issuer in an arrangement with the Scheme or any intermediary in a way which relates to card-based payments or transactions, they are likely to be caught by the interchange fee cap. This will depend upon the specific structure of the arrangement; the broader commercial relationship and flow of fees and services between issuers and Schemes will need to be reflected in the calculation of the capped interchange fee, as will any amount paid by acquirer to issuer.
Under the PSR’s Draft Guidance acquirers are responsible for ensuring the fees paid by them do not exceed the interchange fee cap. Although acquirers may not have visibility over compensation provided to the issuer by the Scheme or other intermediaries, the Draft Guidance requires acquirers to be proactive in ascertaining whether other fees they pay to Schemes or other intermediaries are paid on to issuers (thereby forming part of net compensation) and ensuring this does not result in them paying fees that exceed the interchange fee cap. It is important that acquirers, issuers and Schemes collaborate to ensure that net compensation is correctly accounted for in the calculations of fees payable from acquirer to issuer and to determine how issuers can continue to benefit from advisory services without compromising real revenue in interchange fees.
What next for the Regulation?
The UK government has appointed the PSR as the competent authority to enforce and investigate alleged breaches of the Regulation.
The PSR is currently consulting on its Guidance, which covers the first phase of the Regulation which came into force on 9 December 2015, namely:
- the classification of Schemes
- further details of the interchange fee cap and its exemptions
- the business rules around licensing, the prohibition on steering consumers away from their preferred payment option and information to be provided to the payee
- the PSR’s powers, procedures and approach to monitoring and compliance
- the penalties for breaching the Regulation.
The deadline for responses to this consultation is 29 January 2016.
The European Banking Authority (EBA) is currently consulting on technical standards for the separation of Schemes and processing entities (here), which is included in the second phase of the Regulation. The deadline for responses to this consultation is 8 March 2016.
The PSR will also hold a consultation in Q2 2016 on phase two of the Regulation.