About CMSPI

CMSPI is a global leader in retail payments consulting. Our expert team works to empower the retail community with insights, expertise, benchmarking, and analysis to drive value in their payments supply chain. This consultation response was constructed by CMSPI’s market-leading ‘Insights Team’, which is made up of economists, data and statistical experts, and experienced payments professionals.

CMSPI Response to the Payment Systems Regulator (PSR)

CMSPI welcomes the PSR’s review into the card acquiring market. We think there’s great analysis and the recommendations will help to address some of the problems in the UK card market, but we believe further measures need to be taken to ensure all the issues identified by the PSR’s report are addressed. Our consultation response focuses on 3 main areas where we believe the PSR should investigate in more detail: acquirer absorption, scheme fees and interchange fees.

Acquirer Absorption

The interim report suggests acquirers kept most or all the interchange savings intended for small merchants as well as large merchants on blended pricing structures. While the remedies outlined in the interim report will be beneficial for small merchants, we believe proper enforcement of article 9 of the Regulation (IFR) will also be beneficial in reducing the cost of acceptance for all merchants.

Article 9 (1) of the IFR mandated that “Each acquirer shall offer and charge its payee merchant service charges individually specified for different categories and different brands of payment cards with different interchange fee levels unless payees request the acquirer, in writing, to charge blended merchant service charges”. This was to ensure merchants automatically received the full benefits of interchange reduction.

However, many acquirers in the UK and Europe appear to have interpreted this as ‘opt in’ instead of ‘opt out’. As a result, acquirers have been able to absorb a lot of the interchange savings intended for merchants. Like the PSR’s interim report, the Ernst & Young study commissioned by the European Commission which included data from the UK, found significant acquirer absorption, estimating that 45% of interchange savings had been absorbed by acquirers.1 We believe that the PSR should take a more active role in enforcing article 9 of the IFR which will reduce the cost of acceptance for merchants.

Scheme Fees

Merchants in the UK and Europe have seen huge scheme fee increases since the IFR. The interim report acknowledges that acquirer scheme fees paid to Mastercard and Visa approximately doubled between 2014 and 2018.2 Furthermore, scheme fees have continued to increase even

1 See European Commission Study on the application of the Interchange Fee Regulation, page 158. 2 See Interim report of PSR Market review into the supply of card-acquiring services, page 10.

CMSPI Oxford Place, 61 Oxford Street +44 (0) 161 300 8767 Manchester, M1 6EQ [email protected] United Kingdom www.cmspi.com | @CMSpay

beyond 2018. Our estimates suggest that in the UK, average scheme fees have increased from around 5 basis points to 11 basis points (figure 1).3 If scheme fees remain unregulated, they will continue to increase as seen in Australia and the U.S. (figure 1) where interchange regulation was introduced much earlier.

UK [2015-2020]

U.S. [2011-2019]

Australia [2006-2013]

0.00% 0.05% 0.10% 0.15% 0.20% 0.25% 0.30%

Original Scheme Fee New Scheme Fee

Figure 1 – Scheme Fee Increases by Region4

These scheme fee increases, in conjunction with acquirer absorption, are estimated to have completely eroded the benefit of the IFR in Europe where the average Merchant Service Charge (MSC) is estimated to have increased from 46 basis points in 2015 to 48 basis points in 2020.5

Interchange

As part of the ongoing merchant litigation regarding interchange fees, the UK Supreme Court found Multilateral Interchange Fees (MIFs) to be unlawful and in contravention of Article 101 (1) of the Treaty on the Functioning of the European Union and section 2 of the Competition Act 1998.

3 CMSPI analysis. 4 Europe and U.S. scheme fees estimated using retail data. Europe estimates include inter-regional transactions and exclude local networks. Percentage fees for Australia were calculated using average transaction value of card spend in Australia from Euromonitor. Australian scheme fee data from: https://www.rba.gov.au/publications/rdp/2014/pdf/rdp2014-14.pdf 5 The estimate for the average MSC in Europe in 2015 has been taken from the European Commission’s study on the Interchange Fee Regulation (EY Study). The estimate for the average MSC in Europe in 2020 is made using data from the EY study as well as analysis of retail data. For more information on sources, please refer to the Study published in the following press release: https://www.eurocommerce.eu/resource- centre.aspx#All/13565

CMSPI Oxford Place, 61 Oxford Street +44 (0) 161 300 8767 Manchester, M1 6EQ [email protected] United Kingdom www.cmspi.com | @CMSpay

Given that the most senior court in the UK has found the MIFs set by Visa and Mastercard to be unlawful, we believe there should be an investigation as to the necessity of ongoing interchange fees in the UK.

We have seen evidence of local card schemes functioning successfully without interchange fees such as BankAxept in Norway, Dankort in Denmark, and in Canada.6 Furthermore, abolishing interchange completely was also recommended in Australia by the Australian Productivity Commission in 2018.7 This recommendation was made on the basis that the cost of a consumer’s to use card payments is borne, in part or in full, by the merchant through interchange fees. While these costs may fund things like reward programs that are useful in expanding card networks in their infancy, a mature card market should not require such incentives. Further to this, our analysis suggests that issuing is profitable without interchange fees8 with the great majority of issuing revenue coming from consumer overdraft fees on debit cards and interest fees on credit cards. For these reasons, we believe the abolition of interchange fees should be strongly considered by the PSR.

6 BankAxept does not charge interchange fees for transactions at the point of sale and Interac have introduced a small interchange fee for contactless transactions. 7 https://www.pc.gov.au/inquiries/completed/financial-system/report 8 Our analysis suggests interchange fees constitute around 10% of an issuer’s income, while their profit margins are typically 20-25%.

CMSPI Oxford Place, 61 Oxford Street +44 (0) 161 300 8767 Manchester, M1 6EQ [email protected] United Kingdom www.cmspi.com | @CMSpay