Introduction
Debit interchange fee regulation
Interchange fee regulation alternatives
Potential interchange fee adjustment for certain fraud prevention costs
Non-circumvention and network fees
Coverage of commercial cards and delayed debit
Debit card exclusivity and routing regulation
Network exclusivity regulation alternatives
Routing regulation


Introduction

On December 16 2010 the Board of Governors of the Federal Reserve System released for comment a proposed regulation to implement the debit interchange fee and network exclusivity and routing provisions of the Durbin Amendment – Section 1075 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.(1) The Durbin Amendment added a new Section 920 to the Electronic Fund Transfer Act(2) regarding debit interchange transaction fees and rules for debit card transactions.(3)

For each of the two primary provisions covered by the proposed rule – debit interchange fee regulation and network exclusivity/routing regulation – the board has proposed two alternative regulatory regimes. The board seeks comment from interested parties on each of the two alternatives.(4)

Comments on the proposed rule are due on February 22 2011. Under the Dodd-Frank Wall Street Reform and Consumer Protection Act, the board is required to issue the final rule on interchange fees by April 21 2011 and the rule will become effective on July 21 2011. The board is required to issue a final rule on the exclusivity and routing provisions by July 21 2011, but the statute does not require a specific effective date.

Debit interchange fee regulation

The act states that any debit interchange fee received or charged by an issuer of a debit card must be "reasonable and proportional to the cost incurred by the issuer with respect to the transaction", and directs the board to issue standards for assessing whether the amount of a debit interchange transaction fee satisfies this 'reasonable and proportional' requirement. The statute provided additional guidance on certain factors, which the board was required – or required not – to consider in developing the standards.

Interchange fee regulation alternatives

The proposed rule sets forth two alternative proposals for determining whether an interchange fee complies with the 'reasonable and proportional' standard.

Under Alternative I, all issuers could collect a per-transaction interchange fee up to $0.07 a transaction. Issuers could seek a higher fee, but never more than $0.12 a transaction, based on actual costs. The fee could be no more than the issuer's total allowable costs divided by the total number of debit card transactions during the previous year.

Under the proposed rule, the board proposes to define narrowly the allowable costs that issuers may recover if they set a debit interchange rate above $0.07. Specifically, such allowable costs include only certain costs for authorisation, clearing and settlement services. Moreover, even in those categories, only the per-transaction value of costs (and not fixed or overhead costs) that vary with the number of transactions (average variable costs) can be considered in measuring the interchange fee. The result is that only a limited segment of an issuer's total costs of providing debit card services to customers would be included in the analysis.

Accordingly, Alternative I would require customised interchange levels for issuers seeking more than $0.07 a transaction, and potentially substantial administrative costs to justify such higher fees.

Under Alternative II, issuers would comply with the standard if they set the debit interchange fee at $0.12 or less a transaction.

The board has requested comment on both alternatives, with the intention of adopting only one. The board has also requested comment on other alternative approaches, including approaches based on the average effective interchange fee.

Potential interchange fee adjustment for certain fraud prevention costs

A key cost excluded from the allowable costs used to determine the maximum interchange fee is the cost of fraud. Under the Durbin Amendment, the board is permitted to allow an adjustment to account for fraud prevention costs. The board did not provide a specific proposal to do so, instead seeking further general comment on how to incorporate a fraud adjustment. The supplementary information indicates that the board is considering allowing issuers to recover certain fraud prevention costs, but it is unclear whether this will be allowed only in connection with narrowly defined 'paradigm-shifting' technologies or more broadly. It appears unlikely that a final rule for fraud adjustments will be available when the interchange fee rule is finalised.

Non-circumvention and network fees

The proposed rule does not directly regulate network fees. However, it does state that such fees cannot be used to circumvent the interchange fee restrictions. In general, a finding of circumvention or evasion of the regulation would be based on all relevant facts and circumstances. However, a circumvention of the proposed rule would be deemed to exist when an issuer receives from a network compensation in connection with debit transactions (other than interchange fees) that exceeds the issuer's total payments to the network in connection with those transactions.

Coverage of commercial cards and delayed debit

The proposed rule would apply to business-purpose debit cards as well as consumer-purpose cards. It also includes provisions specifically applying the rule to delayed debit cards and decoupled debit cards.

Debit card exclusivity and routing regulation

The proposed rule also includes regulations, as contemplated by the Durbin Amendment, prohibiting contracts, rules or other arrangements under which a debit card can be processed only by a single network (or only by affiliated networks). The Durbin Amendment also prohibits issuers and networks from inhibiting a merchant's ability to route a transaction over any one of the available networks.

Network exclusivity regulation alternatives

The board proposed the two alternatives to implement the exclusivity provision.

Under Alternative A, a debit card would satisfy the exclusivity provision if it could be used in at least two unaffiliated networks. A debit card that could be used in one PIN debit network and one unaffiliated signature debit network would comply with this requirement.

Under Alternative B, a debit card must function in at least two unaffiliated networks for each method of authorisation that the cardholder could use for transactions. Thus, if a debit card could be used for signature and PIN debit transactions, the card would need to be usable in at least two unaffiliated signature debit networks and at least two unaffiliated PIN debit networks. The board recognised that this second alternative would be much harder to implement.

Routing regulation

The proposed rule would prohibit networks and issuers from restricting the merchant's ability to direct the routing of the transaction over any network that may process the transaction. However, the merchant may choose only from among the networks enabled on the card. The impact of the routing requirement depends substantially on which of the alternative exclusivity proposals is chosen.

For further information on this topic please contact James A Huizinga, David Teitelbaum, John K Van De Weert or Gretchen E Lamberg at Sidley Austin LLP by telephone (+1 202 736 8000), fax (+1 202 736 8711) or email (jhuizinga@sidley.com dteitelbaum@sidley.com, jvandeweert@sidley.com or glamberg@sidley.com).

Endnotes

(1) Pub Law No 111-203, 124 Stat 1376 (2010).

(2) 15 USC § 1693 et seq.

(3) The complete text of the act, including the Durbin Amendment, can be found at http://www.gpo.gov/fdsys/pkg/PLAW-111publ203/pdf/PLAW-111publ203.pdf.

(4) The complete text of the board's notice of proposed rulemaking for the proposed rule can be found at http://frwebgate1.access.gpo.gov/cgi-bin/PDFgate.cgi?WAISdocID=JR8q9B/0/2/0&WAISaction=retrieve.

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