A Revised Interchange Standard for the EFTPOS System – November 2009 6. The Options

Reflecting the feedback received in the consultation process, the Board considered three options.

Option 1: The status quo

Under this option, the Board would leave the regulatory regime unchanged. Interchange fees on EFTPOS purchases would be required to be between 4 and 5 cents paid to the acquirer and transactions with a cash-out component would be unregulated.

Option 2: A new standard for multilateral and bilateral EFTPOS interchange fees

Under this option, the standard implemented would be as set out in Section 4. The weighted average of any multilateral interchange fees set by the EFTPOS system would be required to be below a cap set by reference to the cap on scheme debit interchange fees, currently 12 cents per transaction paid to the issuer. Any bilateral interchange fees would also be required to be below this cap.

Option 3: A new standard for multilateral EFTPOS interchange fees, with regulation of bilateral fees unchanged

Under this option, bilateral arrangements would be grandfathered and remain subject to the current range of 4 to 5 cents paid to the acquirer for purchase transactions. Any multilateral interchange fees would be subject to a cap on the weighted average at the same level as currently applies to scheme debit transactions. This option is based on suggestions made during the consultation process and is designed to address concerns raised about the difficulty of renegotiating bilateral interchange agreements during a transitional period and the access problems that might also ensue from the wider permissible range of bilateral interchange fees.

Assessment

The Board is of the view that the first option would not promote competition and efficiency in the payments system and would hinder the ability of the EFTPOS system to compete with the scheme debit systems. If the status quo were maintained, the recently established EFTPOS scheme would have no flexibility in setting its interchange fees. This would mean that the current interchange fee for purchases would remain between 4 and 5 cents paid to the acquirer. But it might also mean that any interchange fees introduced for new types of transactions would be similarly constrained. The ability to set interchange fees in the best interests of the scheme is an important part of a scheme's competitive strategy. While this may not have been practical prior to the creation of the EFTPOS scheme, the new governance structure now makes such decisions possible. Furthermore, if the status quo were maintained, the scheme debit systems would have a strong incentive to use their more flexible regulatory arrangements to their competitive advantage. In these circumstances, the growth of the systems is likely to continue to be determined in part by the interchange differential, rather than on the basis of the merits of the systems. This would not be in the interests of the efficiency of the payments system.

Options 2 and 3 both have an advantage over Option 1 in that they provide the EFTPOS scheme with the same flexibility as the scheme debit systems in setting interchange fees. Therefore, they both overcome the main disadvantage of Option 1 – the inability of the EFTPOS scheme to compete effectively with the scheme debit systems. The difference between the options is the treatment of bilateral interchange fees.

The advantage of Option 2 over Option 3 is that it attempts, as far as possible, to impose a consistent treatment on all EFTPOS interchange fees, whether bilateral or multilateral. It is not possible to be entirely consistent because, as discussed in Section 4, it would not be possible to ensure a weighted average of bilateral fees complied with the Standard. But broadly, under this option, the industry would be free to set bilateral or multilateral interchange fees with as much flexibility as is currently provided to scheme debit systems. The disadvantage of Option 2 is that, because these are largely interim arrangements, any renegotiation of bilateral interchange fees making use of this greater flexibility might not be in the interests of efficiency. Not only might it be costly for the industry, but it may also divert participants from the more important task of developing a competitive strategy for the EFTPOS system. Option 3 eliminates this risk by leaving the regulation of bilateral interchange fees unchanged.

Option 3 has a further advantage over Option 2 in that it provides much greater protection of the principle of non-discriminatory access. The retention of a cap and floor on bilaterally negotiated interchange fees will limit the ability of incumbents to offer unfavourable interchange fees to new entrants. Multilateral interchange fees have the inherent advantage that they are access friendly because they offer the same interchange fees to all participants. Under Option 3, therefore, participants would be able to agree to an interchange fee outside the 4 to 5 cent range only if it is a multilateral fee.

On balance, the Board is of the view that Option 3 will best achieve its objectives. It will put the regulation of multilateral interchange fees in the EFTPOS and scheme debit systems on a consistent basis but at the same time ensure that participants do not expend resources in costly bilateral renegotiations that may result in access difficulties being exacerbated. Furthermore, the Board is of the view that since this is a transitional arrangement, changes necessary to improve the competitive landscape should be implemented in a way that avoids unnecessary disruption.

Under the preferred option, existing bilateral cash-out interchange fees would remain unregulated. Multilateral cash-out transactions would, however, be subject to the same treatment as any other interchange fee – they would be included in the calculation of the weighted-average interchange fee along with all other interchange fees. There would, however, be no requirement that cash-out interchange fees be set at the same level as purchase transactions.

While the two types of debit systems would be subject to equivalent regulation of multilateral interchange fees under this option, this does not imply that interchange fees in the different systems should be the same. Furthermore, it does not dictate how the greater freedom to set interchange fees should be used by the EFTPOS scheme. This will be a decision for EPAL, based on its judgements about the best commercial strategy. Indeed, it would be possible for EPAL to decide to set a multilateral interchange fee for purchases at the current level. There are, however, potentially many other strategies it might consider, each providing different incentives for issuers and merchants to support the system. In the Board's view, providing the EFTPOS scheme with the same flexibility as scheme debit would leave competition between the systems no worse off and would provide significant potential for it to be improved.

While the Board is easing the regulation on EFTPOS interchange fees somewhat during this transitional period, it is not leaving fees unconstrained. The Board is conscious of the tendency for competition between payment systems to result in rising interchange fees. The Board will be monitoring the development of EPAL's strategy, and in particular its approach on interchange fees, for evidence that it can exert downward competitive pressure on interchange fees in the scheme debit systems.

One final issue that arose during consultation, but was not directly related to the current proposal, was how any transition from bilateral to multilateral fees would be managed. Concerns were expressed about both the detriment that might occur if participants were forced off bilateral arrangements to less favourable multilateral arrangements, and the detriment that might occur to the growth of the system if bilateral arrangements continued indefinitely. While the Board acknowledges that this is an important question, it is hopeful that the industry will be able to negotiate this transition in a manner that takes account of the interests of all participants. For the time being, the Board is prepared to give the industry the opportunity to do so. The Board is supportive of the efforts of EPAL to simplify and improve the governance and operation of the EFTPOS system, including through the setting of multilateral interchange fees, but notes that nothing in the amended Standard requires any changes to existing bilateral interchange agreements.