Retailers pay banks more over payWave/ PayPass than over EFTPOS ©Wigley & Company 2015 page 1 September 2015 Speed read This article summarises the implications for merchants and consumers of the use of so-called contactless cards, in terms of Merchant Service Fees. From this platform, our next article, Mobile payments and competition law, will deal with the same issues as to mobile payments, as part of our series on mobile payments. If you wave your debit card at the shop instead of inserting it into the machine (i.e. you dip the chip or swipe the card), the merchant ends up paying a Merchant Service Fee (MSF) to its bank. Like the use of an EFTPOS card, a debit card issued by Visa or Mastercard, that is inserted rather than waved, runs over the EFTPOS network and involves no transaction charges. But wave the same card and the transaction runs via the Visa/Mastercard schemes, just like Visa and Mastercard credit card transactions do. Most of that MSF effectively goes to the cardholder’s bank by way of the “interchange fee” charged by the cardholder’s bank – the issuer of the card – to the merchant’s bank. Some merchants pass through the MSF to their customers (eg airlines and taxis) but many others (eg supermarkets) don’t. In the latter case the MSF charges are met by all of the retailers’ customers collectively (and/or by shareholders by way of reduced profits). The interchange fee and how it is charged are internationally contentious, as are the MSFs that relate to those fees. Governments and regulators can see the fee as being too high due to lack of market competition. Some countries have regulated the size of the fee (eg Australia has done this and the EU is moving in that direction). The NZ Commerce Commission has also addressed interchange charges. In this article, we will outline some regulatory background and options, looking too at how this is playing out offshore, in the context of this new development: contactless cards. This feeds into our article, Mobile payments and competition law, as essential background for the latter. Our aim is to provide a framework within which the complex position can be considered. This may inform (a) those trying to protect their patch as to how best to do that and (b) those trying to break into the territory as to what to look for and do. It would be folly to come to definitive views on competition law or regulatory risks faced by providers in a short article like this. The Detail The story so far This article follows on from our earlier ones: • How does Apple make money from Apple Pay? • Introduction to NZ mobile payments regulation and law • Cybersecurity risk and mobile payments • Mobile payments and the slippery slope of privacy loss... page 2 Retailers pay banks more over payWave/PayPass than over EFTPOS And this article will be followed by: • Mobile payments and competition law How payWave and PayPass work: overview Take Annabelle in this made up example (made up because the fees as to The Warehouse may be different).1 She buys clothes for $80 at the Warehouse, using an ASB Visa debit card with payWave. Using payWave at the checkout instigates the following steps.2 We’ll start by outlining how interchange fees and MSFs work in the context of contactless card payments. Because it’s a key piece in the puzzle we’ll then look more closely at the Commerce Commission’s interchange settlement as to card payments before those cards could be used wirelessly. Then we’ll look at the Commission’s review of that settlement, followed by off-shore developments. We’ll outline more recent views from the Commission. Finally on interchange fees and MSFs, we’ll check out what differences contactless cards and payWave/PayPass bring to the story. We’ll close by addressing the benefits of collaboration as to banking and payments, along with the fine line between (a) such benefits and (b) potential detrimental impacts on competition and consumers arising out of competitor collaboration. ASB transfers $80 from Annabel’s account, and pays that to the Warehouse’s bank, Westpac, which then credits the Warehouse account. If Annabelle physically swiped or inserted her debit card, this would have been an EFTPOS transaction, over the EFTPOS network, and there would have been no interchange fee and, in turn, no Merchant Service Fee (MSF). But because Annabelle has used the payWave function of her debit card, the Visa scheme and the interchange system is engaged even though the same terminal at the shop is used. That means that, for the payWave-d transaction: • The ASB Visa debit payWave interchange fee of 0.60% applies to this example;3 and • Because interchange fees comprise most of the Merchant Service Fee, Westpac charges a MSF of say 0.75% ($0.60 in the example); and • Of that 0.75%, the majority ($0.48 in the example) is then paid to ASB (the customer’s bank) as the interchange fee. The interchange fee stays with ASB. • Visa charges ‘network fees’ to both ASB and Westpac for participation in the network, data processing, and other services, such as currency conversion for international cards. If Annabelle had used her credit card instead, generally the interchange fee (and, in turn the MSF) would be higher, whether the credit card is waved or inserted. Note: the latest range of credit card interchange fees have changed, including some downwards (we are hearing of charges ranging from well below 2%, to around and even exceeding 2%, but the rates are higher than debit cards: however, the purpose of this article is to outline the framework for consideration). page 3 Retailers pay banks more over payWave/PayPass than over EFTPOS For retailers, there’s a material difference, costs wise (due to MSFs charged by the retailer’s bank), between (a) accepting debit card payments by EFTPOS, and (b) debit payments by payWave/PayPass respectively, just as there is, but at different rates, as between (a) accepting an EFTPOS or debit card, and (b) accepting a credit card. That choice you make at the checkout – to wave the so-called “contactless” debit card instead of swiping the debit card – means the merchant is charged an MSF. This is because payWave and PayPass use the Visa/Mastercard systems, which involves the payment of fees between banks called interchange fees. Those fees are passed onto merchants as MSFs. Most of the MSF paid by the Warehouse goes into that interchange fee. In contrast, swiped debit card transactions are made via the EFTPOS network so, like EFTPOS card transactions, there is no MSF. The Commerce Commission interchange litigation and outcomes This is the best starting point to analyse the position as to interchange fees. Background Some years back, the Commerce Commission commenced proceedings against banks and credit card schemes (eg Visa and Mastercard) in relation to the interchange fees paid by the merchant’s bank (the acquiring bank) to the merchant’s customer’s bank (the issuing bank) for credit card transactions. These interchange fees comprise most of the MSF charged to merchants for credit card transactions, so an interchange fee of 1.6% would translate to a MSF of, say, 2%. The money flows for an interchange fee of 1.6% (MSF 2%) are outlined by the Commission in its own diagram,4 shown on the following page. The Commission alleged that the fixing of the interchange fee component of the MSF by each of the credit card schemes and card issuing banks was anti-competitive under the Commerce Act. It said that this inflated merchant’s costs and led to higher prices for consumers. It also said that the following rules between the banks and the credit card schemes were anti-competitive: • the “no surcharge” rule, by which merchants couldn’t pass on the MSF fees to their customers; • the “no discrimination” rules which prevented certain forms of discrimination between card payments and other payments; • the “access rules” which restricted who could act as an acquirer of Visa and Mastercard transactions. As the Commission later explained:5 “15. The ‘No Surcharge Rules’ and ‘No Discrimination Rules’ were considered anticompetitive as they worked to eliminate opportunities for merchants to create incentives for the card issuing banks to charge lower interchange fees. For instance, merchants could not charge higher prices to consumers for using page 4 Retailers pay banks more over payWave/PayPass than over EFTPOS credit cards, which potentially could cost the merchant more than other forms of payment. The rules therefore shielded credit cardholders from the cost of their payment choice and prevented merchants from recovering the cost or steering cardholders to a preferred method of payment. 16. The combined effect of these rules was that the credit card schemes and banks could collectively set high interchange rates without fear that consumers would switch to other payment options. Merchants could not charge consumers for credit card usage and, given the extensive use of credit cards in part driven by loyalty schemes, were compelled to accept credit cards. The high interchange rates would flow through to higher prices for all consumers. 17. The Commission considered that the scheme rules relating to access were also anticompetitive as they hindered entry by specialist acquirers or self-acquirers (generally large merchants), which reduced competition between the four main card-issuing banks that acted as acquirers in New Zealand.” 4 1541255.1 Summary 1. In 2009, the Commission reached settlement agreements with banks and financial institutions in relation to the setting of fees charged to merchants/retailers1 for accepting credit card payments. This diagram shows the flow of payments in a credit card transaction, A-F 2. These settlement agreements were designed to significantly reduce the average interchange fee (C), or the fee made from the merchant/retailer’s bank to the customer’s issuing bank. 3. The settlement agreements also stopped perceived anti-competitive practices by banks that included a “No Surcharge rule”- stopping merchants/retailers recouping bank costs for credit card transactions through a fee; and “No Discrimination Rules” – which stopped merchants/retailers steering customers to forms of payments other than credit cards. 4. The Commission has been evaluating how those settlement agreements impacted the market between 2010/11 and 2012/13. Data show the average fees that merchants/retailers pay to accept credit card transactions have decreased.2 5. As part of that evaluation, the Commerce Commission surveyed merchants/retailers on credit card payments. The Commission’s survey results indicate that: 1 In this context, merchants are considered to be those that accept consumer payments for various goods and services, for example, retailers. 2 Merchant service fees, the fees that merchants pay for accepting credit card transactions, are comprised mainly of the interchange fee. The interchange fee is a fee paid to the bank of the cardholder. The Settlement In 2009 the banks and the credit card companies made separate settlements with the Commission, which included these commitments:6 “18.1 significantly reduce the average interchange fees charged on New Zealand credit card transactions, ensuring that these fees in New Zealand are driven downwards from the rates that were centrally set by the Visa and MasterCard schemes; 18.2 refrain from any standard contracting practices that prohibit retailers from surcharging Visa and MasterCard Credit Cards as a condition of receiving credit card acceptance services; 18.3 refrain from any standard contracting practices that prohibit merchants from encouraging customers to pay by other means; 18.4 offer retailers the option of unblended service fees; that is offering separate fees for Visa and MasterCard transactions, enabling merchants to see the costs of accepting each scheme’s credit cards; 18.5 offer the option of fully unbundled service fees as offer as between all types of Visa and MasterCard Credit Card transactions, revealing the exact amount of interchange fees applicable to each card transaction, assisting retailers to negotiate lower service fees and provide incentives to consumers to use their preferred payment methods; and 18.6 change the access rules so that acquirers of credit card transactions did not also have to be card issuers or financial institutions.” That’s why airlines, for example, can now add a card charge, but, as we know, many retailers choose not to add a card-use markup. For those retailers, that means that the MSF (which includes the interchange fee) is recovered from all of the shop’s customers (and/or from reduced net profit; ie from page 5 Retailers pay banks more over payWave/PayPass than over EFTPOS shareholders) rather than from the individual customers involved (which was one of the problems identified by the Commission). What has happened as a result? In 2013, the Commission produced a report, evaluating the effect of the settlements.7 Over the period 2010-2013, the Commission considered, based on limited survey evidence, the settlement produced reduced merchant costs of over $70M, when it had anticipated savings in that order. From its limited data it was not able to assess how much of this saving was passed through by merchants to customers. However, it also noted concern that “in some instances the average levels of interchange fees may be starting to increase again”.8 But, said the Commission, as the parties were complying with the settlement agreements, breach of the Commerce Act was unlikely to be the cause. It concluded: “The Commission is not able to address anything other than breaches of the Commerce Act and so alternative regulatory intervention may be required.”9 In referring to alternative regulation, the Commission mentioned the following, on which we expand below: • Part 4 Commerce Act; • the Reserve Bank Act; and • regulation in Australia and the EU, capping interchange fees. Impact of the Commission settlement Whether or not the Commission settlement has been beneficial for consumers, the saving said to be in the order of $70M over 4 years (which is around $20M per annum) is relatively modest and some may even say that it is in margin of error territory. Considering only credit cards (so debit cards are additional to this): • New Zealand’s annual credit card expenditure was over $30bn (on debit cards it was $40bn, totalling over $70bn).10 • Assuming, as a starting point, an MSF average in the order of 2% for credit card payments (a big assumption as outlined above but this will at least help scope the issues), merchants incurred total MSFs of $600m each year, of which the majority (that is, 1.6% of the purchase price)11 goes by interchange fees paid to the customers’ banks. • An average drop in the MSF and/or an average drop in the interchange fees, producing only an estimated $20M per year, relative to $600M per year, implies this might be in margin of error territory (ie no evidence of change) and/or minimal impact of the settlement. • The question of what benefits have been passed through to consumers is also unanswered due to the complexity of that assessment. On top of this, the Commission in its review pointed to increasing fees. International experience Let’s compare NZ with the situation elsewhere. • EU’s 0.3% interchange fee cap New EU regulations passed in April 2015 limit interchange fees to 0.2% (debit cards) and 0.3% (credit cards) per transaction.12 • Australia’s 0.5% interchange fee cap The Australian Reserve Bank imposed a 0.5% credit card interchange fee cap on Visa and Mastercard in 2003.13 Unlike the EU, this cap is a weighted benchmark, which means the average fees accrued by Visa or Mastercard page 6 Retailers pay banks more over payWave/PayPass than over EFTPOS across their product range must fall below the cap. This was imposed under legislation involving the Reserve Bank not the ACCC. The Reserve Bank of Australia is in the process of doing a review. • Ongoing lawsuits in the US In the US, debit card interchange fees are regulated at 21 cents + 0.05% of transaction value. Credit card interchange fees, however, are not regulated. In the absence of regulation, fees are around 1% - 3%, but there are litigation stoushes underway, as we outline in the appendix to this article. Now add payWave and PayPass to the interchange fee recipe Now the interchange system has extended to “contactless” cards (eg Visa payWave and Mastercard PayPass). They are functionally similar, from the customers’ perspective, to debit and credit cards that can only be inserted and, for debit cards, they are functionally similar to EFTPOS. But a key point is that inserted debit cards go over the EFTPOS network, while a contactless payment will go over the different scheme based network. EFTPOS transactions carry no fees but scheme based payments do. These contactless cards are a step on the path to the inevitable domination over time of mobile payments without plastic cards (materially, payments via wireless over smartphones). Some are saying this will even see the demise of EFTPOS, without its transaction fee, replaced by scheme-based payments incurring MSFs. In 2014, the Commerce Commission said this about this development in an internal report:14 “PayWave and PayPass have been touted as the latest and greatest advancement in retail technology, and allow consumers to make a purchase by simply passing a near field communication (NFC) enabled card over a terminal. PayWave transactions have doubled in the last six months and exceed 1,000,000 transactions per month. Despite assurances from the banking industry, there are indications that this technology is currently not as secure as it is claimed, and the [ ] has begun receiving a low level of complaints. Already we are seeing signs that NFC transaction systems are replacing the current EFTPOS payment system with its lower fee structure. This could result in a transaction fee structure monopoly and increased charges to consumers as traders pass on their increased transaction costs through surcharges or increased prices.“ Retailers are not contractually required to configure and use their EFTPOS terminals for contactless payments that involve MSFs. But the Commission’s comments imply possible market failure conditions. Part of the issue is that customers mostly have no idea their choice between EFTPOS and contactless involves higher cost for the trader. And waving is easier than swiping. It’s important to treat that last Commission observation with some reservation: notably it is only in an early stage internal report, with reference to possible monopoly and increased charges to consumers. Some commentators are concerned that even the EFTPOS model, with no per transaction charges, may be side-lined.15 That in turn raises a question: can, and should, the Commission revisit the position in light of changed circumstances since the 2009 settlement? Like all options in this article, that is a complex issue on which we provide no view: we are simply outlining the issues. This is especially important to emphasise as competition law analysis is multi-faceted: what initially appears to be anti-competitive can be the opposite, and vice versa. Importantly, in any new assessment, the Commission would take into account the other emerging payment methods such as mobile payments. That includes the opportunity, even if not already on page 7 Retailers pay banks more over payWave/PayPass than over EFTPOS the drawing board, of disruptive technologies fixing market failure being a relevant factor (or, to the contrary, new technologies extending market dominance, as is implied as a possibility by the Commerce Commission commentary about possible monopoly and increased price conditions in relation to use of contactless cards). Let’s turn now from Commerce Act issues (that is, as to the competition law aspects of the Act, outside possible regulation), to other regulatory considerations. Part 4 Commerce Act regulation The competition law aspects of the Commerce Act can be a blunt instrument: indeed, there is strong criticism of some of the Act’s features in this regard and legislative reform is quite possible beyond the incoming changes outlined early in this article (eg as to s 36 and the activities of providers in a dominant market position). That is one reason why some industries, such as Telco, gas, electricity and airports, have industry specific regulation. The latter three industries are regulated under Part 4 of the Commerce Act. The Commission notes, as to Part 4:16 In most markets, competition delivers benefits to consumers. Benefits include lower prices, better quality, and greater innovation. However, in limited cases, there may be little or no competition and little prospect of future competition. In these markets, the Commission may need to regulate the price and quality of goods and services for the long-term benefit of consumers. Regulation is designed to ensure that suppliers of regulated goods and services have similar incentives and pressures to suppliers operating in competitive markets. Suppliers of regulated goods and services should not be able to earn excessive profits. So, if the Commission decides there are market failure problems as to MSFs and interchange fees, it could go through a process to bring the banks and others under Part 4. This might happen if there is little or no actual or likely competition, with the prospect of exercising substantial market power, where the benefits of regulation exceed costs.17 This would take Part 4 from its traditional footprint (natural monopolies such as airports) to a bigger footprint. As with the competition law aspects of the Commerce Act, the Commission would look at the broader picture such as the impacts of incoming and potential mobile payment solutions (which might be positive or negative). To be clear, there is considerable water to flow under the bridge before a Part 4 threshold decision can be made and the pros and cons are well beyond the scope of this article. Reserve Bank Act The Commission’s 2013 report mentioned this as an option. So far, we do not see its relevance. Legislation change Of course, that is another option too, such as legislation facilitating a decision to cap interchange rates (eg by a body like the Reserve Bank or the Commerce Commission). This would align NZ with jurisdictions such as Australia18 and the EU. Finally on interchange fees…. This is not just about interchange fees, as the terms of the interchange settlement imply. There are many other factors such as new entrants getting access to payment networks, and so on. And on that note, we’ll leave the next instalment on interchange and merchant service fees to our next article, in which we develop the emerging story around mobile payments and competition law….. We turn now to collaboration issues. page 8 Retailers pay banks more over payWave/PayPass than over EFTPOS Collaboration between competitors: the good and the bad Competition law is all about the benefits that competition brings for consumers. That suggests that collaborations, JVs, etc, between competitors, are a bad thing for consumers as they stop competition. However, competition law recognises that some collaborations do not harm consumers and can be beneficial to them, even encouraging competition. Here’s a relevant perspective on the benefits of collaboration in the area we are addressing. Deputy Reserve Bank Governor, Grant Spencer, recently said:19 “A positive feature of the New Zealand payment system over the years has been the extent to which participants have collaborated in establishing payment networks. The development of the domestic EFTPOS system, with a shared service provider switching transactions for a number of banks, is a good example of this… With more players entering the market and the increasing pace of innovation, collaboration may become less prevalent. The recent partial acceptance of a shared Trusted Services Manager [Semble] for mobile payments reflects this trend.” When competitors come together over shared platforms, initiatives, etc, they have to be careful not to step over the mark and breach the Commerce Act provisions that outlaw particular forms of collaborations. Or, more accurately, they need to make sure they fit JV-type exemptions. That includes not only the formal arrangements, such as lawyered agreements but also the day to day activities (eg meetings between competitors might lead to cartel-type allegations if not carefully handled). This will soon get renewed focus, as Commerce Act amendments are well up the order book and they will significantly change competition law as to cartels, JVs and so on, even introducing prison sentences for wayward cartellists. Flowing from this, both under the existing and the forthcoming law, is that industry changes (eg wireless use of plastic cards and also mobile payments) may introduce new challenges from a competition law perspective, that are not answered by the status quo, such as the interchange settlement. But those changes may also have the opportunity to reduce competition problems, such as disruptive technologies along the lines of Uber and airbnb. In this complex world, incumbents such as banks face the commercial – and competition law – challenges as to how to handle their existing platforms and arrangements, such as over EFTPOS, payWave, and incoming mobile payment models. Our aim here is to overview the issues in this complex area, and not achieve the impossible by finding the answers over only a few pages. In particular, it is important to look beyond just one dimension (eg the size of the interchange rate) when drawing conclusions. Appendix - credit card interchange fee litigation in the US In the face of a 2010 US Justice Department antitrust lawsuit, Visa and Mastercard opted to settle and eliminated rules preventing merchants from rewarding customers who opt to pay with lower cost cards. American Express, however, went to trial in 2014 and lost.20 It is currently appealing the verdict. In a different class-action case stretching back to 2005, merchants allege that Visa and Mastercard are in breach of competition law by fixing high interchange fees. After years of litigation, the US courts approved an antitrust settlement of US$7.25bn in 2013 – believed to be the largest page 9 Retailers pay banks more over payWave/PayPass than over EFTPOS in history.21 The settlement, which actually fell to US$5.7bn after thousands of merchants opted-out for various reasons, offers the cash equivalent of an 8 month interchange fee reduction. In return, each merchant is prevented from filing future lawsuits. Many merchants accepted their share of the settlement, but some (such as Google) optedout of the 2013 class-action fund to reach a private settlement, while others rejected the offer entirely and are appealing the settlement or filing new lawsuits (Walmart is currently suing Visa for US$5bn).22 Those objecting to settlement say the offer is poor compensation for the high interchange fees Visa and Mastercard are permitted to charge going forward. There are also concerns that “releases” in the settlement, which prevent future lawsuits, provide the credit card schemes with unfair protection against new technologies:23 Lawyers for objectors expressed concerns that the releases could apply to new technologies such as mobile payment systems. Such systems could give merchants a way to reduce or escape interchange fees unless the card firms “trump” those opportunities, Michael Canter, a lawyer for some of the objectors, said during the hearing. 1. We’ve assumed that 80% of the MSF is the interchange fee, which reflects the position when the Commission settled its interchange case. The position involving The Warehouse, ASB and Westpac may differ. Plus, we have notionally assumed payments in and out inter-bank and between the bank and the merchant. 2. For ease of reference we’ve taken out set offs and so on. 3. The ASB Visa debit card “standard payWave” interchange fee of 0.60%, as stated here: https://www.asb.co.nz/story20147. aspx, may not apply to all merchants. 4. Commerce Commission, Evaluation of the 2009 Interchange and credit card settlements – Research Report (19 Dec 2013). 5. Ibid, at  with footnotes removed. 6. Ibid, at  with footnotes removed. 7. Commerce Commission, Evaluation of the 2009 Interchange and credit card settlements – Research Report (19 Dec 2013). 8. Ibid, at . 9. Ibid, at . 10. According to Statistics NZ. 11. We’ve used an 80% interchange fee to MSF ratio, which reflects the position when the Commission settled its interchange case. 12. EU Regulation 2015/751 on interchange fees for card-based payment transactions (29 April 2015). An updated version of the EU Payment Services Directive (PSD2) will also come into effect later this year. The final PSD2 text is all but agreed, and is likely to significantly impact the mobile payments industry, with new rules as to standardised bank account access, liability for payment providers, transparency of fees, and customer authentication. 13. See Australian Reserve Bank’s “Standard - The Setting of Wholesale (‘Interchange’) Fees in the Designated Credit Card Schemes”, under the Payment Systems (Regulation) Act 1998. 14. Commerce Commission, Consumer Issues 2014 Strategic Intelligence Assessment, para 68 (www.comcom.govt.nz/dmsdocument/13277). page 10 Retailers pay banks more over payWave/PayPass than over EFTPOS Wigley+Company PO Box 10842 Level6/23 Waring Taylor Street, Wellington T +64(4) 472 3023 E firstname.lastname@example.org and in Auckland T +64(9) 307 5957 www.wigleylaw.com We welcome your feedback on this article and any enquiries in relation to its contents. This article is intended to provide a summary of the material covered and does not constitute legal advice. We can provide specialist legal advice on the full range of matters contained in this article. 15. See for example, Credit cards costing small businesses $100 a week (15 July 2015) at http://www.stuff.co.nz/business/money/70217405/credit-cards-costing-smallbusinesses-100-a-week. 16. http://www.comcom.govt.nz/regulated-industries/part-4-inquiries/informationon-part-4-inquiries/. 17. Section 52G, Commerce Act. 18. The Australian Reserve Bank, which can designate systems “in the public interest”, used this legal mechanism to impose an interchange fee benchmark of 0.5% over Visa and Mastercard in 2003. See Australian Payment Systems (Regulation) Act 1998, s 11. 19. Grant Spencer “Reserve Bank perspective on payments” Payments NZ Conference (11 November 2014). 20. American Express v United States (30 April 2015) US District Court, Eastern District of New York, No 1:10-cv-04496. 21. In re: Payment Card Interchange Fee and Merchant Discount Antitrust Litigation (13 Dec 2013) US District Court, Eastern District of New York, No 1:14-md-01720. 22. In re: Wal-Mart Stores (filed 25 March 2014) US District Court, Western District of Arkansas. 23. Bloomberg Business “Visa, MasterCard $5.7 Billion Swipe Fee Accord Approved” (14 Dec 2013) (http://www.bloomberg. com/news/articles/2013-12-13/visa-mastercard-swipe-fee-accord-approved-by-u-sjudge).