Review of Retail Payments Regulation – Consultation Paper
May 2021 Executive Summary

The Consultation Paper presents the preliminary conclusions of the Payments System Board (the Board) following the public consultation process undertaken by the Reserve Bank after the release of the Review of Retail Payments Regulation – Issues Paper in November 2019. The paper also includes for consultation some draft standards that would implement the preliminary conclusions. The Bank seeks comments on these preliminary conclusions and draft standards, with the expectation that the Board will reach its final conclusions in the second half of 2021.

A summary of the key policy proposals is provided below.

Dual-network debit cards and least-cost routing

The majority of debit cards in Australia are dual-network debit cards (DNDCs), which allow domestic debit payments to be processed via either the domestic scheme (eftpos) or one of the international debit networks (Debit Mastercard or Visa Debit). Least-cost routing (LCR), also known as merchant-choice routing, is functionality that lets merchants process contactless (‘tap-and-go’) DNDC transactions through whichever network on the card costs them less to accept. This choice can help merchants reduce their payment costs and increase competitive pressure between the debit networks. Indeed, the average cost of accepting debit card transactions has fallen as LCR functionality has been gradually rolled out over the past few years. Given the potential benefits for competition and efficiency in the payments system, the Board has strongly supported the issuance of DNDCs and the provision of LCR functionality to merchants.

However, the Bank has observed a number of emerging challenges to the viability of LCR. One is a growing number of small and medium-sized card issuers choosing to issue single -network debit cards (SNDCs), typically with an international scheme, instead of DNDCs. Payments using SNDCs can only be processed through the debit network on the card, which prevents LCR. Card issuers considering or choosing to issue SNDCs have pointed to the additional costs of issuing debit cards with two networks instead of one. However, some issuers may also be choosing SNDCs in response to financial incentives from the debit schemes, including higher interchange fees on SNDC transactions (interchange fees are the fees set by card schemes that are paid by the merchant's acquirer to the card issuer on each transaction). The Board is concerned that a significant reduction in DNDC issuance would make LCR unattractive for many merchants. Over time, this would likely impose significant costs on the payments system and broader economy due to the loss of competitive tension between the debit schemes. The Board considers that policy action to limit, and slow, the shift to SNDCs is therefore desirable.

Some merchants have also alleged that the international schemes have been dis-incentivising the take-up of LCR by making low ‘strategic’ interchange rates on credit card transactions conditional on the value or volume of a merchant's debit card transactions. While the Australian Competition and Consumer Commission (ACCC) has carried out some investigations into such ‘tying conduct’, there is scope for the Bank to take additional action to prevent such anti-competitive behaviour.

More broadly, despite the benefits of LCR, take-up by merchants has remained low. The Board has therefore considered whether further policy action was warranted to promote the availability and take-up of LCR functionality for both ‘device-present’ (in-person) and ‘device-not-present’ (online) transactions.

Taking these factors and developments into account, the Board is proposing the following policy framework for DNDCs and LCR:

The Bank would state an explicit expectation that the major banks will continue to issue DNDCs, with both schemes to be provisioned in all relevant form factors offered by the issuer (such as in mobile wallets as well as physical cards). The Board has weighed up the economy-wide benefits from greater DNDC issuance against the incremental costs to smaller issuers of supporting a second debit network. On the basis of the evidence and feedback the Bank has received to date, the Board is not convinced that the benefits of extending any requirement to issue DNDCs beyond the major banks would outweigh the additional costs imposed on those smaller issuers, though it invites stakeholder views on an alternative option of mandating broader issuance of DNDCs.
The Bank's interchange standards would be amended to set a lower cents-based interchange cap for SNDC transactions than for DNDC transactions. This would limit the possibility of schemes using interchange rates to incentivise SNDC issuance, which could accelerate the shift towards SNDCs. (Details of the proposed caps are provided in the following section.)
The Bank would state an expectation that all acquirers and payment facilitators (which provide card acceptance services to merchants) will offer and promote LCR functionality to merchants in the device-present (in-person) environment. The Board does not see a need for explicit regulatory requirements regarding the provision of LCR at this stage. This reflects the progress that has already been made by acquirers and payment facilitators on developing this functionality and the other policy actions being taken to address specific threats to the viability of LCR.
The Bank would state an expectation that the industry will follow a set of principles regarding the implementation of LCR in the device-not-present (online) environment. While the Board supports the provision of LCR online, it seems too early for formal intervention in the device-not-present context as eftpos' online functionality is still being rolled out. However, the Board also has some concerns that online LCR could be hindered by some market participants taking restrictive approaches to its implementation. The Board has therefore set out some principles to ensure that the provision of LCR online appropriately balances the interests of merchants, consumers and the schemes.
The Bank would explicitly prohibit schemes from engaging in ‘tying conduct’ involving their debit and credit card products. This would supplement the implied prohibitions in competition law, helping to ensure that the debit schemes compete solely on the basis of their debit card offerings, thereby supporting competition in the debit card market.

Interchange fees

Interchange fees are wholesale fees set by the card schemes that are paid by acquirers to card issuers on each card transaction. They are passed on to merchants and are a significant component of merchants' cost of accepting card payments. Under the Bank's interchange standards, card schemes must comply with interchange fee benchmarks; specifically, the schemes' average interchange fees, weighted by the value or volume of transactions in each interchange category, are required to be below a benchmark of 0.50 per cent for credit cards, and 8 cents for debit and prepaid cards. The benchmarks are supplemented by caps on individual interchange rates, which limit the disparity between fees applicable to larger ‘strategic’ merchants and smaller businesses. These ceilings are currently: 0.80 per cent for credit cards; and 15 cents, or 0.20 per cent if the interchange fee is specified in percentage terms, for debit and prepaid cards.

The Board's long-held view is that interchange fees should generally be as low as possible, especially in mature payment systems. At present, however, the Board does not see a strong case for significant reforms to the interchange regulations. The current interchange settings have been in effect for only 4 years and appear to be working well. In particular, the Board does not currently see a strong public policy case for lowering the weighted-average benchmarks or the credit card cap.

However, the Bank has noted an increasing tendency for interchange fees on certain debit transactions at smaller merchants to be set at the cents-based cap. The Board is concerned that this can result in smaller merchants facing unreasonably high costs for some low-value transactions (for example, a 15 cent interchange fee on a $5 transaction is equivalent to 3 per cent of the total value of the transaction). To address this concern without significantly changing the overall interchange framework, the Board is proposing to reduce the cents-based debit interchange cap from 15 cents to 10 cents for DNDCs (and all prepaid cards) and 6 cents for SNDCs (the rationale for different caps on DNDCs and SNDCs is explained in the section above). The schemes would still have considerable flexibility to set a range of interchange rates on different types of transactions, including by making greater use of percentage-based fees. Schemes would also have the ability to restructure their interchange schedules if they wished to minimise the impact of the lower cap on overall issuer revenues.

The Board also sees a case for increasing the transparency of interchange fees on domestic transactions on foreign-issued debit and credit cards. The Board is proposing to require schemes to publish interchange fees on transactions on foreign-issued cards on their websites, which would be a low-cost way of shining a light on these relatively high fees.

Scheme fees

Scheme fees are payable by both acquirers and issuers to the card schemes for the services they provide. They are an important component of the costs faced by merchants in accepting card payments (because they are passed on by acquirers), as well as the costs borne by issuers for providing card services to their customers. The Board has held concerns for some time about the opacity of scheme fee arrangements to end-users of the payments system, with some indications that this has allowed for scheme fees to increase over recent years. The opacity could also, in principle, make it easier for schemes to implement fees or rules that may be anti-competitive or have the effect of circumventing the Bank's interchange fee regulation.

Meaningful disclosure of scheme fees could partly address these concerns, thereby improving efficiency and promoting competition in the payments system. At the same time, the Board acknowledges that there is a degree of commercial sensitivity around scheme fees, and that disclosure requirements could increase the compliance burden for the industry. The Board considers that the following proposal strikes an appropriate balance between these considerations:

Schemes would be required to provide the Bank with access to their scheme fee schedules and all scheme rules, and to notify the Bank promptly of any changes to these.
Schemes would also be required to provide quarterly data on scheme fee revenue and rebates to the Bank. The Bank would consider publishing some of the aggregate data, to provide stakeholders with greater visibility over the average levels and growth rates of these fees across schemes. Larger issuers and acquirers would also be required to provide annual data on scheme fee payments to act as a cross-check on the data reported by the schemes.

Surcharging

The Board is not proposing to make changes to the surcharging rules introduced after the previous review of card payments regulation in 2015–16, because these rules are seen to be working well. The Board is not proposing to require any ‘buy now, pay later’ (BNPL) providers to remove their no-surcharge rules at this time but considers that a policy case could emerge in the future and will keep this issue under review.

The Bank's surcharging rules give merchants the right to levy a fee on customers to recover the costs that merchants face in accepting payments using credit and debit cards. This is supported by rules that prevent merchants from surcharging excessively, which are enforced by the ACCC. Most merchants choose not to surcharge card payments, though having the ability to do so can help lower their payment costs and promote competition between card schemes.

A particular issue for this Review is whether businesses that accept payments using BNPL services should be allowed to also apply a surcharge to recover the cost of accepting these transactions. BNPL transactions have been growing very strongly in recent years. These services have been adopted by a significant number of consumers and merchants and are becoming more widely used for certain types of purchases. BNPL services are often free or inexpensive for consumers to use if payments are made on time, but tend to be expensive for merchants to accept. Despite this, providers of BNPL services typically have ‘no-surcharge rules’ that prevent merchants from passing on these costs to the consumers who benefit from using the BNPL service. The Board's long-standing view is that the right of merchants to pass on costs to users of more expensive payment methods promotes competition and efficiency in the payments system. However, the Board also recognises that no-surcharge rules can sometimes help promote competition in the payments market by helping newer services build up their customer and merchant networks.

In considering this issue, the Board has sought to strike a balance between a regulatory environment that encourages innovation by supporting the ability of newer providers of payment services to compete with more established providers (such as card schemes) and providing newer players with an unfair competitive advantage in the medium term.

The Board has reached the view that there is not a clear public interest case for requiring any BNPL providers to remove their no-surcharge rules at this time. BNPL still accounts for a small share of payments in the economy when compared to some other electronic payment methods such as cards, despite recent strong growth. The Board is also conscious that the entry of newer players in the BNPL market has the potential to lead to lower merchant costs without the need for regulatory intervention. However, the arguments are finely balanced and a public policy case could emerge in the future if BNPL continues to grow strongly and becomes an even more prominent part of the retail payments landscape. The Board will therefore keep this policy issue under review in light of market developments.

Other Issues

The Consultation Paper also sets out the Board's preliminary conclusions on several other matters raised in the Issues Paper. These includes the following proposals:

New initiatives to further improve the transparency of payment costs for merchants, to help reduce some impediments to competition in the acquiring market for smaller merchants.
Some minor revisions to the net compensation provisions in the Bank's interchange standards, which include formalising recently issued guidance about when and how new issuers should begin certifying compliance with the provisions.
Revoking the designation of the American Express Companion Card system, given that the four major banks have ceased offering companion cards.
No regulatory action in the digital wallet market at this stage, but ongoing close monitoring of domestic and international developments. While the Bank's power to regulate in this area under current legislation is not entirely clear, this may be clarified following the Treasury's Review of the Australian Payments System.