Reform of Australia's Payments System 5. Consultation on the Preliminary Conclusions

In releasing its Preliminary Conclusions, the Board sought submissions on both its analysis and policy conclusions. In all, 24 submissions were received, including from the card schemes, financial institutions, retailers, industry bodies, consultants and individuals. The majority of submissions are published on the Bank's website. Three submissions were provided on a confidential basis, while one other incorporated some confidential material which has been omitted from the published version. Appendix 1 lists the parties from whom a submission was received on the Preliminary Conclusions.

Most submissions focused on the three options for interchange regulation discussed in the Preliminary Conclusions, with relatively little comment on the Board's assessment of the effects of the reforms. Reflecting the complexity of the issues and the diversity of opinions, few, if any, parties were completely satisfied with any of the options presented. However, of those submissions that expressed a clear view on individual options, the majority (predominantly from financial institutions and card schemes) favoured option 3. Nonetheless, many had concerns with some of its elements, most notably the proposal to further modify honour-all-cards rules. Merchant submissions did not nominate a preferred option, arguing that a move to zero interchange fees across all card systems would be preferable.

The discussion below is separated into two parts. The first summarises the main issues raised in the consultation process regarding the Board's analysis, while the second summarises the various issues raised in response to the three specific options put forward by the Board. Section 6 provides the Board's response.

5.1 Interpretation and analysis

A number of submissions commented on the analytical reasoning behind the Board's Preliminary Conclusions. These comments were largely focused on two issues: the decision by merchants to accept various forms of payment and the benefits of the reforms.

5.1.1 Merchant acceptance decisions

As noted above, the Board has been of the view that the competitive forces on interchange fees in the credit card system are relatively weak, in part because merchants, as a group, are willing to pay more for credit card acceptance than the collective benefit they receive. A number of submissions disagreed with this conclusion, citing various arguments. In particular:

  • Some argued that card acceptance is not a once-off decision for merchants and that it is therefore possible to achieve co-operative outcomes among merchants over time.
  • Some questioned whether a distortion really exists in the system. Some submissions argued that the fact merchants may be willing to individually pay a high price to accept cards reflects competition between merchants, rather than a distortion in the system. Another submission suggested that if merchants have the ability to influence consumers to choose a particular payment instrument, merchant co-ordination is unnecessary. An increase in the prevalence of surcharging, declining acquiring margins and successful bargaining on interchange fees by large merchants were cited as evidence that merchants have the ability to influence consumers' choice of payment instrument.
  • One submission argued that surcharging changes the pay-off for card acceptance and suggested that the combination of lower interchange fees, removal of no-surcharge rules and competition in merchant acquiring has resulted in merchants now receiving collective benefits from card acceptance that are greater than collective costs.

Other submissions acknowledged the complex incentives that merchants can face and argued that one solution to the ‘co-ordination’ problem might be a mechanism that allowed merchants to collectively negotiate interchange fees with issuers.

5.1.2 Benefits of the reforms

In the Preliminary Conclusions, the Board assessed that the reforms had been beneficial for the Australian economy, improving competition and efficiency in the payments system. A number of submissions supported this analysis. A major retailer, for example, argued that Australia's payments system had clearly benefited from the removal of anti-competitive restrictions, improved market access and transparency, and more appropriate price signals that promote more efficient decisions by consumers. Other merchants supported the view that the reforms had been beneficial. A number of financial institutions also highlighted the benefits from the reforms to date, observing in particular the benefits to competition from the removal of restrictions on merchants. A submission by the banking industry agreed with the finding that reforms to access and the removal of no-surcharge rules have been pro-competitive and would benefit the system in the long term.

Other submissions disputed the conclusion that there had been benefits and some questioned the analysis of the welfare gains from the reforms, including the Board's use of the principle of revealed preference. This principle suggests that if consumers use a particular payment instrument at a given price, then they must receive a benefit at least equal to that price. By making assumptions about the number of credit card transactions that have migrated to the EFTPOS system as a result of the reforms, together with data on prices and costs, the Bank estimated that the welfare gains were likely to run into the hundreds of millions of dollars per year.

Submissions typically only addressed this analysis if they disagreed with its conclusions. One of the card schemes argued, for example, that any welfare gain from a shift to EFTPOS was more than outweighed by: the harm to consumers through increased fees; a reduction in rewards and other benefits; and reduced innovation. Two submissions also questioned the underlying resource cost analysis and suggested that there is no evidence that the reforms have had a significant effect on the use of credit cards relative to EFTPOS. On the other hand, another submission argued that recent stronger growth in debit card use than credit card use most likely would not have occurred to the same extent without the reforms, although it postulated that efficiency gains might be at the lower end of the Board's estimates.

A submission by the banking industry, while agreeing that there had been benefits to competition from the reforms, disagreed with the quantitative aspects of the welfare analysis. It suggested that the analysis should account for the loss of benefits to consumers from shifting to EFTPOS use, as well as policy reform costs such as economic and legal costs, interchange cost studies, and staff time. It was also argued that some merchants with market power have not lowered their prices in response to lower merchant service fees, but have instead increased their profits, and that this transfer should be excluded from the welfare analysis.

Another submission argued that those harmed by regulation will have a reduced incentive to innovate and that these costs were missing from the welfare analysis. This submission also questioned whether the principle of revealed preference was an appropriate tool for analysis since it relies upon something which is not possible to observe – behaviour in the absence of regulation.

5.2 The options

Of the three options for interchange fees discussed in the Preliminary Conclusions, the majority of submissions favoured option 3, although most expressed reservations about some aspects of the option. The Australian Payments Clearing Association (APCA), the Australian Bankers' Association (ABA), Abacus and individual bank submissions strongly supported the general approach of this option, but raised concerns about some specific elements. Of the card schemes, two indicated qualified support for option 3 (among the options presented) while a third argued that the best course of action for all parties would be the removal of all regulation. Merchant submissions supported a move to zero interchange fees for all card payment systems and did not express an opinion in their submissions in relation to the three options. One Specialist Credit Card Institution supported a further reduction in interchange fees via option 2. A small number of other submissions – particularly those focused on specific issues – did not express a preference among the Board's options.

Given the balance of opinion, the discussion below focuses predominantly on issues relevant to option 3.

5.2.1 The role of EFTPOS

A key element of option 3 was changes to the EFTPOS system to improve the competitive forces in the payments system. While parties had varying views on the potential impact of a more competitive EFTPOS system, a wide cross-section of submissions supported a change to existing governance arrangements, including the establishment of an EFTPOS scheme. APCA noted that it has for some time been co-ordinating efforts towards improving governance and business development in the EFTPOS system.

Submissions identified a number of benefits that an EFTPOS scheme might deliver. These include: an improved governance structure that would allow decisions to be made for the system as a whole; easier access for new entrants; an improved technological model; centralised setting of interchange fees; and greater ability to innovate. Many submissions argued that a scheme would be worthwhile if it could improve governance and the technological model, but some questioned the extent of benefits beyond that, and in particular whether it could realistically put significant downward pressure on scheme interchange fees.

Some submissions argued that a critical decision for an EFTPOS scheme would be the level of interchange fees. Since scheme debit interchange fees currently flow in the opposite direction to those for EFTPOS, providing issuers with an incentive to promote the scheme products, an EFTPOS scheme may decide to set interchange fees centrally and reverse their direction. Abacus argued that the Board should regulate to achieve this reversal as soon as possible in order to ensure that issuers have the incentive to promote the scheme.

In contrast, merchants argued that there was little need to boost the competitive position of the EFTPOS system. They argued that the system is currently very strong and would remain so while ever it is being supported and promoted by the merchants. Furthermore, by permitting merchants to surcharge or refuse acceptance of scheme debit products, the reforms have provided merchants with the tools to effectively steer customers towards the EFTPOS system. A reversal of the EFTPOS interchange fee might therefore be detrimental to the system because it could undermine merchants' commitment to it.

The merchants also expressed concern that competition between the scheme debit systems and EFTPOS would result in rising interchange fees as the schemes compete for issuers. A submission on behalf of the Australian Merchant Payments Forum noted the ‘dramatic increases’ in PIN debit interchange fees in similar circumstances in the United States. Some merchants argued that bilaterally negotiated interchange fees produced better competitive outcomes than multilaterally determined fees.

While many submissions agreed that an EFTPOS scheme could deliver improved governance, a number – including those made by merchants and small financial institutions – expressed concern that it could also entrench the major banks' dominance of decision making and that the scheme would therefore not take sufficient account of the interests of other stakeholders. Some parties suggested that this issue might be addressed by the appointment of independent directors to the board of the EFTPOS scheme to ensure that decisions were made in the broader interest.

Several submissions took up the suggestion in the Preliminary Conclusions that the development of alternative payment instruments for use in online payments would be expected to improve the competitive environment and, by extension, improve the prospects for deregulation of interchange fees. Some argued that online payments might not be an appropriate direction for EFTPOS and that in order to give the EFTPOS system the best prospects for long-term success, decisions on any developments should be made entirely on the basis of a sound business case. Others pointed out that alternative online payment options either existed or were in the process of being developed.

5.2.2 Further modifications to honour-all-cards rules

Strongly opposing views were expressed on the proposal that the honour-all-cards Standard be extended to give merchants the right to make independent acceptance decisions with respect to any card type that has a separate interchange fee.

A significant number of submissions, largely from financial institutions and the card schemes, opposed any extension of the Standard, arguing that it would: be detrimental to the scheme and issuer brands, which are built on an assurance to cardholders that if a scheme's logo is displayed, its card is accepted; lead to customer confusion and increased search costs; and be particularly disadvantageous for foreign travellers who might not be prepared for their card to be declined. Many submissions also argued that the ability to refuse specific types of credit card was unnecessary given merchants' ability to differentially surcharge.

The merchants, on the other hand, argued that the existing honour-all-cards Standard – which allows independent acceptance decisions for scheme credit and debit products – has been an extremely powerful tool, even though merchants have not actually chosen to refuse scheme debit products. Merchants argued that an extension of the Standard would also be valuable in providing bargaining power in respect of premium cards, although some submissions argued that this power is dulled somewhat by the prevalence of blended merchant pricing and, at least currently, technological constraints on the capacity of merchants to recognise card types.

Merchants argued that any potential customer confusion arising from an extension of the honour-all-cards Standard would be a transitional issue. Customers were not accustomed to merchants selectively refusing scheme cards, but would quickly become so were it to occur.

5.2.3 No-surcharge rules

Arguments for and against the removal of no-surcharge rules were covered extensively in earlier rounds of consultation. Given this, the most recent round of consultation has focused on: surcharges in excess of merchant fees; surcharging in cases where no alternative means of payment is available; the disclosure of surcharges; and the role of no-surcharge rules in ‘new’ payment systems.

The card schemes, smaller financial institutions and the Consumer Action Law Centre argued that surcharging has, at times, been used in an anti-competitive manner by merchants with market power, and that the size of the surcharge often does not reflect the costs of card acceptance. Some submissions argued that card schemes should be allowed to limit the level of surcharges. MasterCard pointed to arrangements in Europe where surcharging is permitted provided that: the merchant clearly indicates the amount of the surcharge and how it will be calculated prior to the sale; and that the amount of the surcharge is ‘reasonably related’ to the merchant's cost of accepting the card. It was also suggested that, if the price signals are to deliver an efficient outcome, the surcharges imposed by merchants on different payment methods need to reflect their relative costs. American Express argued that an acquirer should simply be able to discontinue business with a merchant that is surcharging excessively or in a discriminatory fashion.

Concern was also expressed about surcharging in circumstances where other payment mechanisms are not available. The Consumer Action Law Centre, for example, cited the case of low-cost airfares, arguing that the imposition of surcharges is a hidden cost that ‘distorts competition because it hides the true cost of the good or service from the customer’. It argued that surcharging should not be allowed in these circumstances.

Other submissions expressed concerns about disclosure of surcharges. Abacus argued that some merchants claim surcharges reflect the cost of acceptance when in fact they are substantively above the payment costs. It suggested that the Bank ‘name and shame’ merchants imposing unreasonable surcharges. The Consumer Action Law Centre was concerned about surcharges in some cases not becoming clear to the customer until a point in the purchase process where they had already emotionally committed to the sale and had already provided personal details.

Finally, a small number of submissions argued that there is a case for allowing no-surcharge rules for start-up payment systems. For instance, ACIL Tasman argued that not allowing a no-surcharge rule in such circumstances effectively constitutes a barrier to entry given that the incumbents have already had the advantage of being allowed to build their businesses through the use of such rules.

5.2.4 Transparency

Several financial institutions and the merchants expressed support for increased transparency of average interchange fees and scheme fees. Woolworths, for instance, argued that while publication of average scheme fees would allow merchants to better understand the composition of their merchant service fees, complete transparency of scheme fees is preferable. Visa expressed concern that data on scheme fees are commercially sensitive and disclosure would be inappropriate. It argued that calculating meaningful averages would be difficult and methodologies would need to be specified in considerable detail by the Bank in order to produce data that are comparable and are not likely to distort fee structures over time. MasterCard indicated its willingness to discuss the issue further with the Bank.

APCA suggested that the following industry-wide principles should apply to any requirements for disclosure of average scheme and interchange fees:

  • they should apply fairly across all schemes (including EFTPOS when relevant);
  • commercial confidentiality should be protected; and
  • calculation of any such averages should be consistently applied, to ensure ‘apples for apples' comparisons.

5.2.5 Network choice

Few submissions commented on the Board's observation that the competitive dynamics in the payments system could be fundamentally altered by allowing merchants to choose the scheme through which payments were processed. The merchants, however, expressed support for the idea that they should be permitted to choose how payments were to be processed and urged the Board to reconsider its conclusion that such a fundamental change would require costly adjustments in existing systems and may well have significant unintended consequences. Woolworths argued that network choice should be considered a prerequisite for the Board to consider stepping back from interchange regulation.

5.2.6 Practicalities of option 3

A number of submissions raised questions relating to the conditions attached to option 3.

Some industry participants sought clarity on how to interpret the statement in the Preliminary Conclusions that if average interchange fees in the credit card systems rose materially, the Board would consider reimposition of interchange regulation. It was suggested that this statement introduces regulatory uncertainty that could have a detrimental impact on the card payment systems going forward.

Another issue raised was that the card schemes have no control over the implementation of some of the conditions set out under option 3, and could be significantly affected by decisions made by others. In a similar vein, some financial institutions noted that they have no control over the level of scheme interchange fees.

One suggestion that was raised to deal with at least some of these uncertainties is for MasterCard and Visa to provide a commitment to limit the weighted average of credit card interchange fees – say to the level of the current benchmark. While this possibility was not discussed in the Preliminary Conclusions, a small number of submissions indicated that this was a possibility that warranted further exploration.

APCA and a number of large financial institutions proposed a framework to establish greater co-ordination in a self-regulatory environment. It suggested bringing merchants, schemes and financial institutions together in a structured industry dialogue to: identify, monitor and publish indicators of competition in consumer payment instruments; identify and debate structural opportunities to enhance competition and increase efficiency; and provide a basis for industry discussions with the Bank and the Board on issues of regulatory oversight. In August, APCA provided more detail on this proposal, announcing the formation of the Card Payments Forum.[1]

Submissions also called for greater clarity on some other elements of option 3. In particular, APCA argued that there needs to be greater clarity between industry and the Bank as to what level of reporting, and what milestones, are required in relation to the EFTPOS scheme. Visa also sought clarification of a number of issues, including: what is meant by the continued need for ‘close oversight’ of retail payment systems under option 3; the Board's intentions in respect of debit card interchange fees under option 3; and whether the Board would mandate the inclusion of separate product identifiers on all cards in order to assist merchants in making independent acceptance decisions about different card types. Visa also sought clarification of the regulatory and consultation processes that would be followed in implementing the policies flowing from the Review.

5.2.7 Other options

A number of aspects of option 2 – the position if the conditions for option 3 are not met – also drew comment.

A number of parties commented on the proposed realignment of interchange fees under this option, in particular the establishment of common benchmarks on EFTPOS and scheme debit interchange fees. As discussed above, merchants argued that changing the direction of EFTPOS interchange fees would remove their incentive to promote EFTPOS. From a different perspective, Visa also argued that alignment of the weighted-average benchmark for scheme debit and EFTPOS was inappropriate because a significant proportion of scheme debit use is in card-not-present environments where interchange fees are set at a higher level to cover costs associated with a higher fraud rate. Since EFTPOS cannot currently be used in card-not-present environments, setting the benchmarks at the same level would mean that the schemes would have to set card-present interchange fees at a lower rate than EFTPOS.

Abacus and Australian Settlements Limited agreed that if option 2 were adopted, the direction of EFTPOS interchange fees should be reversed, but argued that the scheme debit benchmark should not be reduced given that the cost structure and benefits of the scheme product differed from EFTPOS.

Merchants opposed the removal of the current exemption of EFTPOS cash-out transactions from the EFTPOS interchange Standard. A submission on behalf of the Australian Merchant Payments Forum argued that if the EFTPOS interchange benchmark is reversed as proposed in option 2, interchange fees on cash-out only transactions should be set to zero. Individual retailers argued that they should be free to separately negotiate fees on cash-out transactions and might be unwilling to provide the service otherwise, while other submissions suggested that a direct charging arrangement, equivalent to the new ATM regime, would be appropriate.


Australian Payments Clearing Association Media Release, ‘New Card Payments Forum’, 14 August 2008. [1]