Chapter 6 Payment Cards and Interchange Contents 6.1 Introduction and synopsis .....................................................................................228 6.1.1 Evolution of means of payment and arrangements between banks ..............228 6.1.2 What is interchange? ....................................................................................229 6.1.3 Three-party (“closed”) and four-party (“open”) card schemes........................230 6.1.4 Necessity of interchange in principle.............................................................232 6.1.5 Danger of abuse and how best to prevent it..................................................234 6.1.6 A transparent and objective interchange methodology..................................236 6.1.7 Interchange and other payment streams.......................................................237 6.1.8 Card scheme rules .......................................................................................237 6.2 Payment cards in South Africa ..............................................................................237 6.2.1 Types of cards and card transactions ...........................................................237 6.2.2 Global development of payment cards and electronic payments...................238 6.2.3 Card issuing in South Africa..........................................................................241 6.2.4 Continued predominance of cash .................................................................245 6.2.5 Global strength of Visa and MasterCard .......................................................256 6.2.6 Network advantages of four-party schemes..................................................257 6.3 Merchant acquiring and merchant service charges.............................................263 6.3.1 Merchant acquiring in the three-party and four-party schemes .....................263 6.3.2 Scheme rules and practices in the allocation and management of risk .........268 6.3.3 Flow of payments in three-party and four-party schemes..............................270 6.3.4 Merchants accepting cards ...........................................................................273 6.3.5 Interchange enters into consumer prices ......................................................277 6.3.6 Competition among acquirers in the four-party schemes ..............................278 6.3.7 Eligibility for participation as acquirers in the four-party schemes .................280 6.3.8 Restrictions on cashback at the point of sale ................................................291 6.4 The setting of payment card interchange .............................................................294 6.4.1 History and level of card interchange in SA ..................................................294 6.4.2 The “Edgar Dunn” process and the decision of the banks in 2003 ................295 6.4.3 The Visa exemption ......................................................................................298 6.4.4 The MasterCard advisory opinion .................................................................299 Banking Enquiry Report to the Competition Commissioner Contains confidential information Chapter 6 Payment Cards and Interchange 226 6.4.5 The current MasterCard / “Edgar Dunn” process ..........................................301 6.5 Revenues and profitability in issuing and acquiring............................................301 6.5.1 Banks’ revenue from card issuing and merchant acquiring ...........................301 6.5.2 Growth rates in costs, revenues and profits ..................................................305 6.5.3 Profits in card issuing without interchange ....................................................306 6.6 The necessity of interchange in principle.............................................................307 6.6.1 Competition policy and joint ventures ...........................................................307 6.6.2 Origins of interchange in card payment schemes .........................................308 6.6.3 Interchange is not a price for service ............................................................310 6.6.4 The nature of the joint venture in “open” (four-party) schemes......................311 6.6.5 Rules to enable co-operation ........................................................................312 6.6.6 Revenue allocation in a two-sided market.....................................................314 6.6.7 Default, multilateral and bilateral setting of interchange ................................321 6.6.8 The absence of interchange in some countries.............................................324 6.6.9 The profitability of issuing without interchange..............................................329 6.6.10 Conclusion on the necessity of interchange ..............................................330 6.7 The potential for abuse of interchange and the need for regulation...................331 6.7.1 The non-neutrality of interchange .................................................................331 6.7.2 Do market forces limit card interchange so it cannot be abused? .................333 6.7.3 The nature of the potential abuse .................................................................337 6.7.4 Unsatisfactory methodology..........................................................................342 6.7.5 Illegitimate benefits would extend to three-party schemes ............................350 6.7.6 The need for regulation.................................................................................350 6.8 Interchange in other payment streams .................................................................351 6.8.1 Introduction...................................................................................................351 6.8.2 Electronic funds transfer (EFT) .....................................................................352 6.8.3 Early debit orders (EDO) ..............................................................................359 6.9 Appropriate regulation of interchange..................................................................371 6.9.1 International experience ...............................................................................371 6.9.2 An independent, objective and transparent process......................................375 6.9.3 Participation in the process...........................................................................378 6.9.4 The methodology..........................................................................................379 6.9.5 Avoiding negative consequences of regulation .............................................385 6.10 Other rules of the schemes...............................................................................388 6.10.1 The “honour all cards” rule ........................................................................388 6.10.2 The “honour all products” rule ...................................................................390 6.10.3 The rule against surcharging.....................................................................392 Banking Enquiry Report to the Competition Commissioner Contains confidential information Chapter 6 Payment Cards and Interchange 227 Tables Table 1 Percentage share of debit and credit card market .................................................243 Table 2 Payment cards issued by the big four banks in SA................................................244 Table 3 Number of merchants acquired by the big four banks in South Africa ...................273 Table 4 Merchant service charges (MSC) ..........................................................................274 Table 5 Merchant classification..........................................................................................274 Table 6 Card interchange levels in South Africa.................................................................296 Table 7 Turnover, revenue, costs and profits from issuing and acquiring in 2006 ..............302 Table 8 Average revenue from interchange per transaction...............................................303 Table 9 Gross and net revenue from interchange fees: the big four banks.........................303 Table 10 Revenue from the MSC: the big four banks together...........................................304 Table 11 Profit growth rate in the acquiring market ............................................................305 Table 12 Profit growth rate in the issuing market ...............................................................306 Table 13 Profit to cost ratios ..............................................................................................306 Table 14 Issuing profits without interchange ......................................................................307 Table 15 EFT debit and EFT credit interchange or homing fees ........................................353 Table 16 Volume growth of EFT transactions ....................................................................357 Table 17 Participants in the EDO streams .........................................................................362 Table 18 AEDO interchange fees paid by Absa .................................................................363 Table 19 Interchange fees and user fees for successful AEDO and NAEDO transactions .366 Table 20 Split of user fees for successful AEDO transactions............................................367 Table 21 Fee and revenue split for AEDO and NAEDO – R500 transaction.......................370