Transcript of Question & Answer Session Merchant Payment Costs and Least-cost Routing

Claire Wivell Plater (Moderator)

Well, I don't think actually our participants on the panel today need a great deal of introduction, and besides, you have them up there. So I won't bore you with a bio about them. But just perhaps get straight into things. The current payments regime and regulation of payments was put in place in 1998 following the Wallis Report, which saw a major shakeup of the way financial services generally, were regulated. And, when we look at it now, we see that we have three major regulators, and one industry body regulating payments. We've got the RBA with the Payment Systems Board responsible for promoting efficiency, competition and stability, and banks, visa and other credit cards, EFTPOS and ATMs have all been designated as payment systems, and of course there are interchange standards that apply. The RBA is also responsible for financial stability and it operates through Real-time Gross Settlement System.

But it is supported very heavily of course by AusPayNet who are sponsoring this conference, who developed the rules for and administer five different clearing systems. Then we have APRA, who unfortunately are not represented here today, who are responsible for a prudential policy and we've got ASIC, who are represented by Michael today, projecting consumers and ensuring market integrity. And so, the question I ask myself when I, sort of, re-familiarising myself with entire panoply of payments regulation, was if you were looking down on Australia from Mars, and thinking about starting a payments business here, or even if you were just humble startup from within the country and you looked at that plethora of regulators and regulation, would you have designed it the same way today? And I'd like to pass that to our panel. So, what are your thoughts about that? What would, could we simplify, should we simplify, and if so, what impact might that have. Tony.

Tony Richards

Thanks Claire. A couple of observations on our regulatory system. Danielle said that you have to negotiate with a lot of different regulators in Australia, but actually in the payments system, regulation is pretty light. From the Reserve Bank's point of view where we have responsibility for competition, efficiency, and stability, we've actually used those regulatory powers very infrequently. And for example, there is no requirement for payment systems, or participants in payment systems to be licensed in Australia. Now, some of the entities you're talking about probably would actually like there to be more regulation. But it's an interesting concept that you've the market saying, please regulate us. Please give us more regulation.

A second observation is that at one level it can appear quite appealing to have a single regulator. But I think there are some perils here, and if you look what happened in the UK, they moved the responsibility for prudential supervision and for market conduct into the same institution, the FSA in the late 90s, I think. But, they've split it up since. And I think one of the risks of putting lots of different responsibilities into the one regulator, is they may focus too much of their attention on one of their responsibilities and some of the other ones may slip and I think that's recognised that happened in the UK.


So, Tony, you're in charge of competition in the payment system. So, how would you propose to address those issues and particularly the issues … One of the comments made by the House of Representatives Standing Committee on Economics, when they were looking into competition in the banking industry is that, pricing power, the problem with the fact we've got a little competition is that pricing power can be used to extract excess profits, and obviously that's a concern that Danielle has raised very fairly and squarely in relation to the NPP. We understand that there are four, the four major banks and a number of other banks who will be able to provide other participants with access to the NPP, but what would the RBA be able to do in order to make sure that there's sufficient competition there?

Tony Richards

The Reserve Bank has powers to designate payment systems, and if we thought it was in the public interest, we can do so. And my expectation is that we would have the power to designate the NPP, the New Payments Platform, if we saw concerns about competition, efficiency or risk. We're hoping we won't need to, and we've spent a lot of time … working with the industry on the governance of the NPP. The NPP's going to have an independent chair. I believe the NPP is about to appoint a second independent director. Up till now, the Reserve Bank has been at the table both from a settlements point of view, but also the Reserve Bank's policy side has been an observer at the NPP Board.

So, we think that governance is heading in the right direction. I would note that for the NPP participants, board representation is shared between the large banks, the four majors, and also the smaller institutions. And that includes representation by service providers for the Credit Unions and Building Societies. So we think that there's a lot of positive things about the governance of the NPP. If we thought that its rules were being used to deny access on reasonable terms, then we would have the ability to designate it and to set some form of access regime. But at the moment, I think our inclination is to say, let's see how it works and we're very positive that it'll be a force for improving the services that are provided to end users in the community.


Thanks very much. That perhaps leads me to a question that, this is a Dorothy Dixer because Tony has asked me to ask this question, which is about interchange fees. The RBA has kept a very careful eye on interchange fees over the years, and has the ability to flex its regulatory muscle, in ever so gentle ways that seem to cause change. So Tony would like to, I think talk a little bit about one of those changes that's about to happen. I think you've got a small presentation Tony that you'd like to …

Tony Richards

Yes. The issue, it's a bit broader than just interchange. It's about the cost of payments to merchants, because as we know there's a lot of talk about the shift that's occurring from older payments methods towards electronic payments. For example, in the recent discussions around the Black Economy Taskforce, merchants expressed a lot of interest in switching from cash to electronic payments. But they've also expressed concerns that electronic payments can be quite expensive. So, today in this little session, I wanted to summarise some new data on the cost of payments to merchants and then discuss least-cost routing, which is a current policy issue in this area and which the Governor mentioned this morning. A fuller version of what I'm saying will be posted on the Bank's website.

The Bank recently asked all the larger acquirers to provide some anonymised merchant-level data on payment costs. We asked for data for 2016/17 on the average cost of payments for all of the four-party card payment systems. This has yielded a really interesting dataset of around 680,000 merchant accounts, which you can see here. It's a scatter plot, which shows the average total cost of card payments for all those merchants. And we've capped it, so that we're not showing those merchants for which there's a cost of card payments which is above 6%. But, as you can see, there's a wide range in the cost of payments for merchants.

But let me put all that information in a more digestible form. This next graph divides merchants into ten different groups ranked by the value of their annual transactions. So each group accounts for about 10% of the value of all card transactions. The first group includes the smallest merchants. There're about 490,000 merchant accounts there with annual transactions averaging about $92,000. The tenth group includes the largest merchants, which is 35 merchants with average transactions of $1.3 billion. And it shows the average cost for the different payment schemes but with MasterCard and Visa grouped together. It clearly shows that larger merchants have lower payment costs and it shows that debit cards are cheaper than credit cards.

But let me focus now on the cost of debit card transactions. The average gap between those two bottom lines (in the graph) can be viewed as a measure of the difference in average costs between EFTPOS and the international schemes, which controls for differences in merchant size across those schemes. And that gap suggests that debit transactions via the international schemes typically cost merchants about 44 basis points more in 2016/17.

But, it's important to control also for other compositional differences. One possible split is to divide merchants into two groups: those which accept both EFTPOS and the international schemes, these are likely to be bricks and mortar merchants, and those which only accept the international schemes, these are likely to be billers and online merchants.

So this graph shows the result of that exercise. It shows that there's still a large difference in the cost of debit transactions for those merchants which accept both EFTPOS and the international schemes, and there was an average gap of 39 basis points in 2016/17.

Another difference in transaction mixes is that some MasterCard and Visa transactions will be on international cards, which have higher merchant service fees. So, we've done some figuring, which suggests that this may explain part of the difference in this graph, possibly about a quarter of the difference.

The overall message appears to be that EFTPOS is generally a less expensive payment method for merchants even after controlling for a number of factors. And that shouldn't be surprising because scheme fees and interchange fees have both tended to be lower for EFTPOS than for the international schemes.

That's not to say that EFTPOS is a lower-cost scheme for all merchants. Our data show that international scheme debit is less expensive for merchants accounting for about 4% of the value of debit card transactions and there's a little difference in cost for merchants accounting for about further 8.5% of transactions. But EFTPOS is less expensive for the large majority of merchants representing about 87% of the value of card transactions.

Those data that I've shown are for the 2016/17 financial year. So, they pre-date the reset of interchange fees for the international schemes that occurred on 1st of July. And we don't have merchant-by-merchant payment costs for the recent period, but we do have some aggregate data from our regular statistical collection. And those data show that there was a fall of three basis points in average merchant fees for MasterCard and Visa transactions in the September quarter. So there's been a modest narrowing in the gap.

Let me turn now to the issue of least-cost routing. Just as merchants are keen to hold down other business costs, they're also keen to hold down their payments costs. And recently, they've drawn attention to a particular issue that's driving up their cost of payments.

The majority of debit cards issued in Australia are now dual network cards, which means that authorisation of debit transactions can occur through either of two networks. If you look at your debit or your ATM card, there's a good chance it'll have an international scheme logo on one side, and it'll have the EFTPOS logo on the other side. And most cards in terminals are now also activated for tap and go via EFTPOS as well as the international schemes. But when banks send out the dual network debit cards, they're programmed with the international scheme as the first priority for tap-and-go use and the EFTPOS network as the second priority.

Now most cardholders are indifferent about which network processes their contactless transactions. Both networks can link to the same debit account. There're typically no rewards programs on debit transactions. And customers get similar protections from fraud and disputed transactions based on the ePayments code, and the chargeback policies of the three schemes.

However, many merchants have a preference for transactions to be processed by the EFTPOS network. So many merchants have been calling for their acquirer banks to provide them with least-cost routing. This could mean that terminals are programmed to always send dual network tap-and-go transactions via a particular network. Or a terminal might use dynamic rules, which identify the lower-cost network for each transaction.

Now the Bank has discussed the possible implementation of least-cost routing with consumer organisations and with the ACCC. We think it would be desirable for merchants implementing least-cost routing to disclose this to customers. This could be a sign saying that the merchant will typically send tap-and-go debit card transactions via a certain network, but noting that customers who wish to send their transactions via a different network could insert or dip their cards and then could push the button or the keypad for their preferred network. We think such a model could be a reasonable balance between the rights of merchants and consumers. And we think it's likely that consumers would quickly become used to the idea that their transactions could be sent via different networks at different merchants.

Until recently however, acquirers have indicated some reluctance to provide least-cost routing for their merchant customers. In addition, some merchants have expressed concerns to the Bank that the international schemes might resist the implementation of least-cost routing.

Now if transactions via the international schemes are currently more expensive to merchants, one possible outcome of least-cost routing becoming available would be for the international schemes to reduce their scheme or interchange fees so that merchants don't have much of an incentive to send transactions via another network. However, some merchants are concerned about other possible responses. These could include increasing interchange rates that apply to a merchant's credit transactions if they implemented least-cost routing of their debit transactions. Or it might involve attempting to persuade issuers to stop issuing dual-network cards. The ACCC is aware of these concerns and is closely monitoring the situation. And with passage of the Harper reforms, which came into effect in November this year, it now has even stronger powers to investigate and take action in relation to potentially anti-competitive conduct.

So, as you may be aware, at its November 17 meeting, the Payments System Board strongly supported calls from a range of stakeholders for acquirers to provide least-cost routing functionality and it noted that a prompt industry, or a market-led, solution was preferable to regulation.

More recently, the House of Representatives Standing Committee on Economics has recommended that banks give merchants the ability to send tap-and-go payments from dual- network cards through the channel of the merchant's choice, and the Committee recommended that if the banks haven't facilitated this recommendation by April 2018, that the Payments System Board should regulate to require this to occur. Recent indications are that all four of the major banks are moving to providing least-cost routing if requested by merchants, though in some cases they have indicated this could occur on a fairly extended timetable. But some of the smaller acquirers may be able to move more quickly.

Accordingly, the Bank expects that by early in 2018, there'll be some concrete indications that a critical mass of acquirers are moving to provide least-cost routing and that the international schemes are not attempting to prevent this. However, if this expectation is not met, I expect the Payments System Board will consider consulting on a regulatory outcome, a regulatory solution which deals with all the relevant considerations.

So Claire, that's a quick tour of some issues involving debit cards. As the economy shifts away from paper-based payments, it's important that the payments system provides end users with access to low-cost electronic payments. That's the message the Governor gave clearly this morning. We think debit cards are an important element of this, so we think it's natural for the Bank to be focusing on the competitive forces in this market.


Tony, would you like to comment on an innovation hub for RBA?

Tony Richards

Do you mean an innovation hub or a regulatory sandbox?

Danielle Szetho, CEO Fintech Australia

I'd be happy to start with an innovation hub.

Tony Richards

Right. Well, as the Governor said this morning, the Reserve Bank is looking closely at what a lot of fintechs and financial institutions are doing … what their plans are for, you know, distributed ledger technologies, digital currencies, et cetera. And we're considering participating in some proofs of concept ourselves, and we're observing other proofs of concept by particular entities. So, we're out there looking at what's happening. The idea of actually setting up an innovation hub, that's not something that we've considered, and it's not something actually many central banks have done. There are few, but it's often those central banks that have got a mandate, either an implicit or explicit mandate, to promote their country or their city as a financial centre.


It's a cool thing, isn't it when you get regulated competition and the competition that we've got going at the moment is who can be the most facilitative of innovation, which I think is a wonderful thing for our countries. And actually, just going to back to that stats, in ASIC's report just last week, and I mean, I've been very familiar with this having taken many businesses down to the innovation hub, but they have assisted to date, 233 businesses, and facilitated 38 licences and 11 variations of licences, which is a pretty outstanding record, you know, in a really very short period of time.

So, in the early days of the innovation hub, I'd be the first to say and you know Michael, they were finding their away and there was, we used to do a lot of pushing, didn't we, Danielle, you know, that we thought they could be perhaps more helpful, but I have to say that currently the experiences that they are extraordinarily helpful and particularly in finding your way to that very person in ASIC that you need to talk to.

So, I've just got one last topic that I want to cover and this is a bit of a, sort of, out of left field topic, and it's really about this whole concept of blockchain, and where it's heading, because I know the Governor said this morning that he sees Bitcoin as being a blip on the horizon if you like, and a massive, sort of, bubble, and I don't think these are the words he used, but, what we're seeing in the work that we do with innovative businesses is that this new form of fundraising called Crypto Tokens where people are raising through what is an Initial Coin Offering, which is equivalent to an initial public offering, only it's not sitting under the Corporations Act regime at this stage. And one way that they are avoiding the need to sit within the IPO regime is to design those tokens in such a way that they become a means of access or means of payment for a product or access to a service, which is a very interesting concept if you think about it.

But, the reality is, what are we going to see. Well if businesses, and the Governor mentioned this morning that he was open to this, are going to create these internal payment ecosystems and we have lots and lots of stored value systems in effect where people are holding tokens, which have value in digital wallets, should we be looking at those from a regulatory perspective? Should we be saying, well, should they be regulated to make sure that people's value, which they are being required to store in those pieces of software in order then to gain access to systems, should be regulated. So I'm just really interested to hear, and I know this is slightly out of left field, except I'd warn you yesterday, both of you, interested to hear what your views are on that, Michael.

Michael Saadat, Senior Executive Leader, ASIC

So, it's difficult. Because I think there are two questions you could ask in this kind of situation, which, and the first question is possibly the easier question but the answer is often not that helpful, and that is, you know, how does the regulatory framework deal with these new things? And there's a strict legal answer that you might come up with. But, sometimes that answer is pretty unsatisfactory, because it's based on legal rules that were designed that did not contemplate any of this new technology. So, I guess that first question is important. You know, we shouldn't, you know, ignore the fact that we do have a framework, and we need to understand how things interact with that framework.

But potentially the second and more important question is, how should these things be regulated, and that's more important because I think the point of regulation is to deliver good consumer outcomes to foster confidence in the financial system and to allow innovation to take place. So, to answer that question we need to be conscious for all these other things. But, sometimes the answer to the second question is not clear, because we don't really know how some of these new things will develop. Some of them are still emerging, and we always worry about the risks to consumers. So, we put out an information statement recently on ICOs and in that we talk about the uncertainty, we talk about the things that need to be balanced. We threw in a bit of a warning I think as well for consumers to be wary about some of these things.

We're trying to juggle a whole range of things with some of these new technologies. And so sometimes the answer is kind of a bit wait and see, and keeping a sort of a watching brief on some of these things, because if you give a quick answer to those questions, you can potentially hinder innovation that would otherwise be quite good, and so we're being conscious of that. We're naturally risk averse I would say, but we're trying to be open minded and engage as much as possible on some of these things. And I think a good example of this natural tension is, if you think about screen scraping technology and account aggregation technology, this is a situation where for 20 or 30 years we've told consumers, do not share your passwords with anybody. You know, this is the one clear message we've given consumers. Do not share your passwords.

And now, we have a situation where we're saying well, maybe you can share your passwords in some situations, you know, depending on who you're interacting with and what the purpose of that interaction is, which is a much more nuanced message. And you know, those nuances can get lost and then you can have a situation where consumers lose money or there are scandals that emerge because of those kinds of things. You know, that is the natural tension, and we're being conscious of that, but I think we're very interested and we'll keep watching developments in this space.


Indeed. And if open banking goes the way we think it's going to, we'll all be sharing passwords. I'm now out of time Harry and I'm really sorry but I really want to, just if we could, hear Tony's answer to that, and Tony you've got 30 seconds.

Tony Richards

For these ICOs, I think we view them largely as a vehicle for raising capital in an unregulated way. But we haven't seen any that we think that are primarily payments functionality. We would ask ourselves if it was a purchased payment facility that required authorisation. We haven't seen anything that meets that test. Alternatively, we could ask ourselves is this ICO somehow a payment system, and if it met that test, does it raise any competition, efficiency or systemic risk issues. These things are all pretty small – I can't see how they raise systemic risk issues to that extent. I can't see how they would raise competition issues. They're not normally trying to keep players out, if anything they're trying to bring people in, so I don't see we'd ever need to implement access regimes. So, at the moment I don't see any regulatory issues needing addressing.


Okay, great. Thanks, and I'm really glad I gave you notice of that question …

Danielle Szetho, CEO, Fintech Australia

Can I just add one quick point?


You'll have to ask Harry, not me.

Danielle Szetho, CEO Fintech Australia

One very quick one.



Danielle Szetho, CEO Fintech Australia

We have a great startup who's here: Living Room Of Satoshi that's enabling people to pay using cryptocurrencies for normal bills. Last time I spoke to him, which was a few months ago, he was saying to me that he was processing some $500,000 a week in bills for people paying in Bitcoin. He's now passing 4,000,000 dollars in payments a week. Witness that growth, and I think that's a conversation that can continue.


Yes. Well I think it's a conversation that's certainly needs to continue but we're not going to have time to do it now. So I would you to join with me in thanking our panel, Danielle, Michael, and Tony.