Is European interchange regulation toothless?

IFR legislation was passed on 10 March, 2015 by an overwhelming majority of 621 votes to 26. This legislation will see domestic credit card interchange fees capped at 0.3% of the transaction value with domestic debit card transactions capped at 0.2% on a weighted average basis. If implemented in its entirety, CMSpi estimates that merchants across Europe will save a total of EUR 4.2 billion (USD 4.7 billion) annually, or 48%, on their existing interchange bills, although this will differ significantly by merchant depending on transaction profiles.

It would be easy for merchants to assume that the IFR represents a firm and final victory for the merchant community in achieving fair interchange fees. However, CMSpi research suggests that, for UK merchants, the current proposals issued by Visa and MasterCard fall more than GBP 800 million (USD 1,247 million) short (annually) of the European Commission’s original mandate.

We forecast that the GBP 2.41 billion (USD 2.7 billion) UK merchants paid in interchange fees in 2014 should be reduced to GBP 0.958B (USD 1.1billion) under full IFR, as it was originally understood. However, the current proposals would see annual interchange fees reach GBP 1.763 billion (USD 1.9 billion), much closer to the 2014 level than the full IFR level. So, why is there such a big gap? The following is a summary of the main issues.

Timelines

It will be many months before interchange is capped. Before the regulation comes into force, it needs to be officially endorsed by the Council of Ministers, then the regulation needs to be published in the Official Journal of the European Union and, finally, a 20 day waiting period must then be observed. It is then the responsibility of individual member states to ensure that the caps are implemented within 6 months of the legislation coming into force.

Overall, we expect it will be November or December 2015, before the caps will come in, which is far too late considering this debate has been rolling on for decades.

EUR 0.07 cap, removed from the IFR cap

Amendment 30 to the IFR, made by the European Parliament in April 2014, introduced an important stipulation: the debit card cap would be as low as 0.2% of the transaction value or EUR 0.07 per transaction. For a transaction of EUR 100 (USD 111), the EUR 0.07 cap would lead to a reduction of EUR 0.13, or 65% of the interchange fee paid.

However, Article 16(k) of the final compromise text document, published by the Council of the European Union in January, 2015, states that the EUR 0.07 per transaction debit card cap will, in fact, not be initially introduced and will only be implemented if approved when a review of the regulation takes place four years after it is introduced.

Instead, an amended structure will be introduced whereby for any given transaction, card schemes are allowed to charge up to EUR 0.05 per transaction on a fixed basis and up to 0.2% of the transaction value on an ad-valorem basis, as long as the weighted average interchange fee paid across the entire card network does not exceed 0.2%.

Up until March, 2015, UK merchants did not pay more than GBP 0.08 for any EMV face-to-face Visa consumer domestic debit card transactions. With the IFR however, there will potentially be no limit at all. Across the UK, CMSpi estimates that the exemption of the EUR 0.07 cap will cost merchants GBP 363 million (USD 566 million) and, for merchants with a high average transaction value, this will have a potentially devastating effect.

Commercial cards excluded

Although it was initially unclear whether commercial and three party cards would be included within the scope of the regulation, the final text confirmed that they have been excluded. This exemption is an unfortunate defeat for the merchant community, and the GBP 442 million (USD 698 million) that has been lost to these sources is, in the short-term, at least, irretrievable (the latest documentation suggests that third-party issued three party card networks will come into scope in 5 years).

Circumvention

Article 5 of the final compromise text states that circumvention of the IFR via interchange replacement fees is prohibited. However, the actual wording of the clause only specifies this with regards to interchange. We would like to see it confirmed that network fees are prohibited from replacing interchange fees.

Acquirers

Finally, CMSpi are also concerned that card acquirers may see the regulation as an opportunity to increase their profit margins by only partially passing on the benefits to merchants. Indeed, in other jurisdictions where interchange has been regulated, such as the US, there is strong evidence that the profitability of acquirers has seen a marked increase following regulation.

About Callum Godwin

Callum is a Research Analyst at CMSpi, a leading global payments consultancy. Callum has penned multiple white papers on the card supply chain and the affects international interchange regulations are having on merchants.

About CMSpi

CMSpi is an independent team of expert consultants and analysts, who advise global merchants how to optimise and reduce their payment acceptance costs. CMSpi work across all areas of consumer payments and the objective is always to secure the best end-to-end solution for the clients. We add significant additional value to current supplier arrangements as we bring unique insight, analysis and benchmarking along with over 20 years’ of experience in all areas of the consumer payments supply chain.