A Variation to the Surcharging Standards: A Consultation Document – December 2011 4. Policy Options

The Board has weighed the options regarding modification of the Standards at two levels. First, it has considered whether modification of the Standards to allow schemes to place a limit on surcharges is in the public interest, and second, it has considered the form that any modification should take. These questions are dealt with separately below.

Is there a Case to Modify the Standards?

The Board remains of the view that the benefits of the removal of no-surcharge rules have been substantial, reflecting the improved price signals that have been provided to cardholders and the resulting improvements to the overall efficiency in the payments system. This transmission of more accurate price signals to consumers is also an effective discipline on acceptance costs, which should, over the long term, reduce upward pressure on interchange fees. The Board, however, remains concerned that surcharges in excess of the cost of card acceptance, and the blending of surcharges for cards with differing acceptance costs (particularly at rates above the acceptance cost of the lower-cost card), are reducing the effectiveness of the earlier surcharging reforms. The Board is aware that, under the current wording of the Standards, the industry is prevented from addressing even the more extreme cases on its own. While the original intent was for the Standards to provide a mechanism for surcharges to be limited to the fees incurred by the merchant for a card transaction, should both parties agree, over time it has become evident that this provision has not been as effective as originally intended.

Following the consultation and further work by the Bank, the Board considers that surcharging is now sufficiently common, and surcharging above the cost of acceptance sufficiently widespread, that an unconstrained capacity for surcharging may no longer be appropriate. The Board is of the view that relaxing the Standards to allow schemes to limit surcharges would provide a number of public benefits. It is likely to generate more efficient price signals than if the Standards were left unchanged and the inefficient surcharging practices that have developed over recent years continued. In addition, whereas consumers currently have little capacity to assess whether a surcharge is reasonable, the ability for schemes to enforce surcharge limits if needed is likely to provide consumers with greater confidence that surcharges are in line with merchants’ cost of accepting cards. This is likely to result in increased acceptance of surcharging by consumers and merchants and, therefore, has the potential to further increase the incidence of surcharging and improve price signals to consumers.

The Board has weighed the expected benefits from modifying the Standards against a number of potential drawbacks that have been noted during consultation. First, it has been suggested that a modification to the Standards may constrain merchant bargaining power. When the surcharging reforms were first put in place, the Board sought to place as many bargaining tools in the hands of merchants as possible, given the public's presumption that merchants would not surcharge. The Board's assessment is that surcharging is now sufficiently common, and surcharging above the cost of acceptance sufficiently widespread, that an unconstrained capacity for surcharging is no longer appropriate. In any case, it is not clear that giving the schemes the ability to limit surcharges will have a significant effect on merchants' negotiating power; while merchants have indicated that the threat of surcharging has enabled them to negotiate lower merchant service fees, it is unlikely that the threat of surcharging well above the cost of acceptance is significantly more effective than the threat of surcharging alone.

A second potential drawback of modifying the Standards is that the schemes may either seek to apply the revised Standards in a way that makes it more difficult for merchants to surcharge, or apply restrictions aggressively across the whole merchant base, resulting in high compliance costs. The Board is of the view that an appropriately worded Standard would reinforce the rights of merchants to recover their card acceptance costs. This is discussed further below and in Section 5. The Board also believes that the schemes and acquirers will jointly have an incentive to find an appropriate balance between managing excessive surcharging and ensuring that compliance costs are not unnecessarily high.

The Board has also considered the possibility that excessive surcharging could be addressed and price signals improved without varying the Standards. Under this approach, the Reserve Bank would make a public statement clarifying that the intent of the Standards is for merchants to pass through an amount to consumers that reflects the cost of card acceptance. The Reserve Bank may also provide some specific guidance that it is expected that card surcharges would be no more than a certain percentage of the transaction value, potentially differentiated between the three-party and four-party schemes reflecting differences in acceptance costs.

The effect of such a statement may be to set expectations about acceptable surcharge levels, both for merchants and consumers. In this way it may cause consumers to question higher surcharges and place pressure both on merchants that already impose surcharges that are excessive and on those that may consider doing so in the future.

This approach has the advantage over the status quo that it potentially provides at least some constraint on the surcharging practices that have concerned the Board, and does so at low cost. On the other hand, moral suasion alone might not be sufficient to change the behaviour of some merchants – particularly those with some market power. Some merchants may, therefore, require an element of compulsion to bring surcharges into line with card acceptance costs.

A statement that identified a specific surcharge level that might be considered reasonable could also potentially suffer from concerns about those levels becoming the norm for surcharges and would not account for the large differences in acceptance costs among merchants (see discussion under Option 1 below).

On balance, the Board is of the view that relaxing the Standards to allow scheme rules to impose some limit on surcharges will result in the most efficient outcomes and is in the public interest. The options for varying the Standards are considered below.

Options for Varying the Standards

In weighing the options to modify the Standards, the Board considered the advantages and disadvantages of being more prescriptive in its approach relative to providing a little more flexibility to schemes in setting surcharge limits. It considered three options: setting a specific permissible cap itself; allowing surcharge limits to be set in line with merchant service fees or some function of the interchange fee; and allowing surcharges to be limited to a reasonable cost of card acceptance.

Option 1: Specific permissible surcharge limit

Under this option, the Board would determine a specific permissible surcharge limit, possibly expressed as a percentage of the transaction value, for the designated MasterCard and Visa credit card systems, and the Visa Debit system.[1] This would be the lowest limit that scheme rules could choose to impose; that is, scheme rules could limit the surcharge that a merchant could apply, but could not prevent the merchant from applying a surcharge up to the limit determined by the Board.

As set out in the June 2011 Consultation Document, this option has the appeal of being transparent and makes monitoring of compliance relatively straightforward. The practical difficulty with this approach, however, is that the Board would be required to determine an appropriate level for the surcharge limit across all merchant types and sizes. Inevitably, for some merchants the limit would be higher than the cost of acceptance and may encourage merchants to simply set surcharges at the limit determined. For other merchants the limit may be too low and may therefore prevent them from recovering their costs and providing appropriate price signals to cardholders. A fixed permissible limit for surcharges would also be unresponsive to competitive pressures that might influence average merchant service fees over time.

As discussed in Section 3, nearly all submissions to the initial consultation were opposed to this option for these reasons.

Option 2: Surcharge limit equal to the cost of card acceptance

A second option is to modify the Standards to allow scheme rules to limit surcharges to the merchant's cost of card acceptance, and for this cost to be defined clearly as part of the Standards. As discussed in the June 2011 Consultation Document, this option raises the difficulty of determining the appropriate cost of acceptance, particularly if a wide range of other costs, such as annual fees, terminal rental or other transaction fees are to be included along with the merchant service fee. While one approach might be to only include ‘other’ costs that are charged by the acquirer, there are also a range of legitimate costs for card transactions that, for some merchants, may not be charged by their acquirer. For example, while some merchants rent their terminals from their acquirer and incur terminal rental fees, others invest directly in terminals themselves; if only costs charged by the acquirer are included, merchants that rent their terminals from their acquirer would be able to impose higher surcharges than those that own them. Similarly, in the case of online transactions, some merchants use a payment gateway, which may differ from the merchant acquirer, to process their card transactions. In addition, ‘other’ costs may not always be entirely attributable to acceptance of a particular card; terminals, for example, may process many types of payment methods and the costs would therefore need to be apportioned accordingly.

Given these difficulties, a simple and consistent approach across all merchants under this option would be to define the cost of acceptance as the merchant service fee. The main benefit of this approach over Option 1 is that surcharge limits would vary with the cost of card acceptance for each individual merchant and so would send more appropriate price signals to cardholders. Therefore, concerns about setting a limit too high or too low would be reduced. The June 2011 Consultation Document also suggested that under this option some sort of tolerance around the cost of card acceptance could be expressly allowed for in any revised Standards, such as for rounding purposes.

The Board recognises, however, that a number of arguments have been made against this approach. One is that acquirers have the ability to alter the mix of fees included in the merchant service fee, which would have a direct effect on the amount any given merchant would be able to surcharge. For example, acquirers may have an incentive to include a wider range of costs in the merchant service fee in order to attract the business of merchants that wish to impose higher surcharges. Second, the merchant service fee may not adequately reflect all the costs of accepting card payments, with some variation in these other costs across industries. And third, merchant service fees are commercial-in-confidence between the merchant and its acquirer, which means it would be difficult for the four-party schemes (and the public) to monitor merchant compliance with the surcharge limit.

A variant of this option, suggested during consultation, is to allow scheme rules to set a surcharge limit as a specified function of the interchange fee – for instance a multiple of the interchange fee or the interchange fee plus a set margin. The key benefit of this approach over using the merchant service fee is that interchange fees are more transparent, with fees for individual card and transaction types published and the weighted average of fees for each four-party scheme capped at 0.5 per cent of the transaction value by the Reserve Bank. This means that it would be relatively easy for the schemes and consumers to monitor merchant compliance with the surcharge limit. It would also eliminate the possibility, discussed above, that acquirers might seek to incorporate a wider range of costs in the merchant service fee to attract merchants that wish to impose higher surcharges. Another benefit of this approach is that it may be more effective in placing downward pressure on interchange fees by creating a direct link between these fees and surcharges; schemes would need to balance the desire to set higher interchange fees with the likelihood of facing higher surcharges.

The principal drawback of this approach is that it would not reflect genuine differences in card acceptance costs where they are not related to interchange fees and so would suffer some of the same drawbacks as Option 1.

Option 3: Limit surcharges to a reasonable cost of acceptance of cards

A third option is to allow the schemes to set limits that are a little more flexible. The proposal considered here is to allow a scheme's rules to limit surcharges to a reasonable cost of acceptance of cards of that scheme. A reasonable cost of acceptance would not be defined, but would include, at a minimum, the merchant service fee. As noted in some submissions to the consultation, an approach that provides some degree of tolerance in the setting of surcharges has been adopted in New Zealand and parts of Europe.

The key advantage of this option is that it provides the flexibility to consider the different costs that may be faced by different merchants and industries. In this way, it is likely to generate more efficient outcomes to the extent that it enables surcharges to reflect better the cost of acceptance across a wide range of different types of merchants.

A potential drawback of this approach, though, is that it may take longer to establish new surcharging behaviours as schemes and merchants determine what is ‘reasonable’ on a case-by-case basis.

The Board's Preferred Option

After considering the various options in light of the developments in surcharging practices over recent years, the Board is of the view that the benefits of varying the Standards to allow schemes to limit the level of surcharges outweigh the costs. In particular, such a variation would be in the public interest because it would allow the card schemes to address cases where merchants are clearly charging more than is justified for card acceptance, a practice that may distort price signals and result in inefficiencies in the relative use of payment methods. Nonetheless, an appropriate variation of the Standards would continue to allow merchants to pass on the legitimate costs of accepting cards.

On balance, the Board is of the view that Option 3 – allowing a limit based on the reasonable cost of card acceptance – would be the most effective way to relax the Standards. The Board believes that this is the approach that is likely to result in the most efficient outcomes; by not being too prescriptive, it will enable surcharges to best reflect the actual costs of card acceptance faced by each individual merchant.

The Board wishes to stress that this approach is aimed at improving the efficiency of the payments system and may not necessarily address all surcharging practices that are viewed by the public as being of concern. This approach does not, for instance, prevent surcharging in circumstances where there are only limited payment alternatives available. It does, however, provide the capacity for the schemes to ensure that the surcharges collected in these circumstances reflect card acceptance costs.


For this, and the other options considered below, the American Express, Diners Club and Debit MasterCard systems would be expected to modify their relevant voluntary undertakings accordingly. [1]