The Most Important Three Little Words in Payments?

The Most Important Three Little Words in Payments?
No, not “I Love You” or “Buy Celent Research”. But That, Which and May. The long running saga around Durbin interchange fees took another twist last week. To recap, a group of merchants (knowns as NACS) sued the Federal Reserve, arguing that the Durbin rule it had imposed exceeded the authority granted by Congress to the Federal Reserve. To many peoples surprise, in July 2013, U.S. District Judge Richard Leon upheld that opinion and ruled that the Federal Reserve did not comply with the Durbin. The opinion was generally harsh on the Fed, with the judge writing: “The court concludes that the [Federal Reserve] Board has clearly disregarded Congress’ statutory intent by inappropriately inflating all debit-card transaction fees by billions of dollars.” The judge also ruled that the Federal Reserve failed to ensure that merchants enjoy access to “multiple unaffiliated networks” to process each debit-card transaction, as also required by the Durbin Amendment. In short, the judge ruled that the Fed needed to re-write the Durbin amendment. In January 2014 the case went to the US Court of Appeals, with literally billions of dollars at stake. Last Friday, March 21, saw the panel overturn the initial ruling, and the Durbin Amendment stands. This is a significant victory for the Fed and the banking industry, and major blow for the retailers. So why the title of this blog? In their decision, the judges severely criticised the quality of the drafting of the report. In particular, the use of the word “which” instead of “that” became central to the decision. That’s two of our three words. It reminds me of the issues in implementing the Payment Services Directive in Europe. The PSD was published in French, German and English. Understandably, the numbers of words varied between documents. But oddly, so did the numbers of paragraphs. That was the first issue – a belief that not everybody was working to the same document. With English the business language of many of the international banks, and English being spoken more widely than the other two languages, more countries used the English version as their starting point. And that’s where the trouble began. The word “may” was used widely throughout the document – over 200 times. The nuances of English language education meant that some read the word as permissible; some read it as optional; whilst other again assumed it meant they had to. A simple word, but very important differences in understanding. The consequence is that the next draft of the PSD is trying to address issues that it never assumed would be issues! Three simple words which (that?!) most of us probably never think about yet had billions of dollars in implications!

The Latest Assaults on Card Fees

The Latest Assaults on Card Fees
I said last year that I can’t really take a summer vacation – too many things seem to happen in payments while I am away. This year was no different with many interesting stories to catch up with from new chiefs at MCX and Visa Europe to PayPal trying out check-in payments in the UK to the latest announcements from Isis (I will try to review those in a separate blog.) However, two big news items really caught my eye, both to do with further assaults by regulators on card interchange fees. As Gareth already described in his blog, the European Commission confirmed its intentions to cap interchange fees across Europe to 0.2% for debit and 0.3% for credit. The enactment is expected to take one to three years for European Parliamentary approval and approval by a majority of EU member states. Caps will start applying to cross-border transactions two months after final approval and for domestic transactions after 24 months, so some of the caps could be introduced as early as late 2014. If and when this happens, it will have major repercussions to the industry – the banks will have to seriously question the viability of offering credit cards, are likely to be more open to experimenting with non card-based solutions (e.g. bank account), yet the merchants incentives to accept anything other than cards and card-based solutions would be seriously diminished, dampening the prospects of innovation and start-ups. If the EC announcement was expected, the news from the US was anything but. While the industry was still getting to grips with the aftermath of Durbin amendment, the District Court Judge Richard Leon threw out the $0.21 debit interchange fee cap set by the Federal Reserve and suggested that the Fed should review and lower the cap further. If the cap went down to $0.12 or even lower, the banks would stand to lose another $4bn or more in revenue. The Judge’s decision also appears to impose more routing requirements than the Fed’s ruling did, which even in the original implementation turned out to be a big stumbling block for EMV. What will this latest turn of events do for EMV prospects in the US? If there is one thing certain is that it will only create more uncertainty for the industry, making the original dates for the liability shift even more difficult to achieve.

“Should We Repel Durbin?”

“Should We Repel Durbin?”
That was the question someone asked me last week at an ATM, Debit and Prepaid Forum. I know – it was in Vegas, the person was joking and the question is really a rethorical one. And yet, it kind of rings true, because no one seems to be happy with the new regulation. Except, of course, the lobbyists, lawyers and other industry advisors. And perhaps some acquirers and ISOs. As expected, “Life after Durbin” discussions dominated the event. Of course, the large debit issuers are unhappy – the general consensus is that this will wipe out about $8bn in annual interchange revenue for the industry. The issuers are looking for ways to cut costs or to raise revenue. It was interesting to watch how nearly everyone had to update their slides, as Bank of America withdrew their planned $5 debit card fee about 24 hours before the official conference started. The bank itself explained that they “listened to the customer feedback and acted accordingly.” The smaller exempt issuers are not entirely unhappy. Credit unions announced a large new customer intake (“760k new accounts in the last 10 days, more than in the entire year previously”). However, they are worried that they will also feel competitive pressure on interchange or might be discriminated by the merchants and their acquirers. Also, it remains to be seen how profitable the new customers will be for them. Prepaid issuers seem to be unsure what to make of it. On one hand, some prepaid cards are exempt from regulation, however, the exemption conditions and small print gets very complex very quickly. Cue in the lawyers and corporate counsels to help navigate the regulatory maze. The network routing rules banning the exclusivity arrangements are seen as an opportunity by at least some of the networks, especially the smaller ones. However, the implementation – renegotiation of contracts, setting up of routing rules, etc – is not an insignificant undertaking for all involved. Cue in consultants and more lawyers. Perhaps most surprisingly, the merchants are not happy at all. The merchant panel, represented by senior executives from Walmart, 7-Eleven and McDonald’s was one of the most interesting sessions at the Forum. They all expressed disappointment in the final regulation. Walmart said that the regulation was a “disappointment, but a good start for future regulatory reforms, including credit.” It is true that for small ticket purchases, the costs of debit acceptance have gone up, as it’s now a flat fee, i.e. the cap was implemented also as a floor. When asked if and when consumers can expect to see lower prices, the merchants responded by saying that the “merchant market is very competitive, therefore any cost changes will be passed to consumers, both increases and decreases”. In other words, “expect prices not to change much or perhaps even go up.” Redbox, a US-based DVD rental firm, already followed through on this and raised its prices for DVD rentals from $1 to $1.20 quoting increases in their costs of debit processing. Smaller merchants are also unhappy because it might take time for any savings to trickle through to them. Unless their acquirers and processors charge them “interchange plus”, they may find it difficult to demand immediate reductions in their bundled fees. Those with lower volumes may also lack the necessary know-how or may simply prefer avoiding the hassle of putting pressure on their acquirers to lower their fees. It will take a better part of next year for the full effects of Durbin regulations to become clearer, but the early signs are that it won’t reach all of its intended outcomes. So, what’s next? P.S. As an aside, this year’s ATM, Debit and Prepaid Forum saw the best-ever attendance – over 1,100 participants – and had a very interesting agenda with great speakers. Congratulations and thank you to SourceMedia, the event organisers, and Tony Hayes, a conference chairman (and a partner at Oliver Wyman, Celent’s parent company) for all their efforts!

Durbin D-Day

Durbin D-Day
Finally, the wait is over. Yesterday (June 29th), the Fed’s Board approved and announced the final version of Regulation II, known in the payments industry as the Durbin amendment, which sets out the rules for debit card transactions. Financial institutions feared the worst after the initial proposals annouced in December last year. Today, banks can breath a sigh of relief. In both of the major issues on the table – the interchange caps and the rules for network exclusivity – the Fed’s final rule is better than the proposed worst-case scenario. Visa’s stock closed the day at $86.57, up by $11.29 or 15%. For the interchange, the Fed settled on a cap of 21 cents on transactions that fall within the regulation’s scope. Furthermore, the banks can charge an additional 0.05% of each transaction’s value. Finally, another 1c could be added if the banks’ fraud-prevention systems were deemed adequate by the Fed. Given this, an issuer still needs a $100 transaction to break-even based on the issuer’s average transaction cost of $0.27, which was outlined in the Industry’s comment letter to the Fed during the consultation period. However, it is a significant improvement over the originally proposed cap of 0.12c per transaction. For network exclusivity, the Fed opted for Alternative A, i.e. the issuers will have to place two unaffiliated marks on every debit card, which is most likely to translate into one signature and one PIN network. Again, this is not as drastic a change as it would have been under Alternative B, which would have demanded two network choices for each method of payment (i.e. two signature and two PIN). Even though the final rules are not as harsh as the worst-case proposals, the financial industry is still worse-off and will have to adapt. The retailers should be declaring victory, however, instead, The National Retail Federation expressed “serious disappointment” and called the final rules “a major loss for American consumers.” The new rules will go into effect on 1 October, 2011. The cloud of uncertainty has been lifted and the industry can get on with final preparations and implementation. The numbers can be plugged into the scenario models built up by various institutions over the last year to finalise the expectations of impact, the relevant systems can be upgraded accordingly and the contract negotiations (e.g. around network affiliations) can proceed with certainty. Of course, as we all continue to study the final rules, more questions will emerge. And, as the dust settles, there will be unexpected outcomes and consequences of this momentous ruling. But this morning, the US financial institutions should reflect that it could have been a lot worse.

The Unintended Consequences of Regulation

The Unintended Consequences of Regulation
Last week I attended Celent’s Innovation and Insight Day in Atlanta and had an opportunity to catch up with many of our clients, both banks and technology vendors. One of the banks told me an interesting story how after Reg E came into force, they saw a drop in debit card usage and a significantly increased demand for cash. As many of you know, Reg E requires a customer to opt-in to an overdraft facility for debit transactions at the point-of-sale. The regulation’s intention was good – to protect consumers from unexpected overdraft charges. However, the outcome was an unintended steer back towards cash at the point of sale. Many consumers didn’t understand the requirement to opt-in and having had their card declined at the POS due to insufficient funds in their current account, lost confidence in shopping with the debit card. If there is no easy way to check balance and there is a risk that the transaction might be declined, then it is easier just to withdraw cash and use that for purchases instead. As a result, the bank is faced with an unexpected increase in costs and efforts to forecast cash demand and replenishing ATM’s in time to meet that demand. According to a meeting notice published on its website, the Fed plans to meet on June 29 to discuss “Debit Card Interchange Fees, the Fraud Prevention Adjustment, Routing and Exclusivity Restrictions and related matters”. As the Durbin saga is nearing conclusion with the final rules expected to be announced after the meeting, there is a risk that this regulation will also have far-reaching and unintended consequences. Celent has just re-published an Oliver Wyman article series called “Durbin Second-Order Effects“. Oliver Wyman’s partner Andrew Dresner and the series’ author argues that by reshuffling the relative costs between debit, credit and alternative payments, Durbin will have as profound an impact on other actors in the payments ecosystem as it does on debit issuers. Do you agree? Do you have other examples of unintended consequences of regulation?

Replacing debit interchange with a new fee?

Replacing debit interchange with a new fee?
Over the weekend I read an open letter by Senator Durbin to JP Morgan Chase CEO Jamie Dimon regarding interchange fees. In the letter Senator Durbin sets outs his arguments for why the Senate was compelled to introduce debit interchange regulation, which overall makes a very interesting reading. One paragraph especially caught my eye (my Bold Italics highlighting): “Last year Congress decided that there should be reasonable regulatory constraints placed on Visa and MasterCard to ensure that they cannot use their market dominance to funnel excessive interchange fees to the nation’s biggest banks. A strong bipartisan majority supported my amendment, which said that if Visa and MasterCard are going to fix fee rates on behalf of banks with over $10 billion in assets, those rates must be reasonable and proportional to the cost of processing the transaction. It is important to make clear that if Chase wants to set and charge its own fees in a competitive market environment, the amendment does not regulate those fees. The only regulated fees are those fees that banks let card networks fix on their behalf.” This got me thinking… does this mean that the issuers are free to introduce a new fee, which they could charge the acquirers in lieu of interchange, lets say an “authorisation” fee? Of course, any issuer who goes first faces to be at a competitive disadvantage to others, at least initially. The industry players don’t have to collude to raise prices with various signalling techniques available to them and given the market clout of the largest issuers. I am sure there would be other challenges (e.g. technical, etc.), but is this completely out of the question? Why? What do you think?