Following our recent article ‘Card Acquirers under the spotlight: PSR turns the microscope on Scheme Fees and Interchange Fees’, this Q&A addresses the broader questions arising from the PSR’s proposed market review into the supply of card-acquiring services.
What is the Payments Systems Regulator, what are its objectives and what are its powers?
The PSR was set up in April 2015 as an economic regulator for the £81 trillion payment systems industry in the UK. It is an independent body that is funded by the industry and is accountable to Parliament.
The PSR has a very specific remit and its statutory objectives focus on promoting: (1) the interests of businesses and consumers; (2) effective competition between operators, PSPs and infrastructure providers; and (3) the development of and innovation in payment systems.
The PSR has a full range of regulatory and competition powers. Since it was set up three years ago, we have seen it issue directions to take action and set standards for the payments industry, and refer matters to the Competition & Markets Authority where it sees anti-competitive behaviour.
What are the key elements of the draft ToR?
It is important to consider the draft Terms of Reference (ToR) of the review in the context of the UK payments regime generally, in particular the various changes that the industry has experienced in recent years. These include:
- Regulatory changes: When the Interchange Fee Regulation (IFR) came into force in 2015, interchange fees for card payments were capped for the first time at 0.3% for consumer credit cards and 0.2% for consumer debit and prepaid cards. The IFR is due for review by the European Commission in June 2019. In addition, following the implementation of PSD2, we have seen an increase in competition in the payments space. This has resulted from the introduction of account information and payment initiation services and the opening up of access to third party providers.
- Changes in consumer practices: There has been a significant increase in card-based transactions. Debit cards overtook cash as the most frequently used payment method in the UK for the first time last year, and the number of merchants accepting card payments is also on the up.
- Merchants are feeling squeezed: Despite the interchange fee cap, many merchants claim they have not seen a reduction in their merchant service charges, and in some cases they have actually gone up. This means that merchants are finding themselves in a position where they are prohibited from passing on the cost of the use of credit and debit cards, yet they are seeing no economic benefit from the interchange fee caps.
Against this backdrop, the PSR proposes to examine both the level of competition amongst UK acquirers, and the outcomes of the competitive process - looking at the fees merchants pay and the quality of service they receive.
What does the scope of the review reveal about the PSR’s regulatory intent?
The market review will cover the supply of card-acquiring services. The PSR uses the term ‘acquirer’ in the broad sense, to include both acquirers and payment facilitators. The PSR will also consider the role that ISOs play as a channel for acquirers to sell their service.
The PSR has excluded ancillary services from the scope of its review, which would include, for example, the supply of point-of-sale terminals. In addition, the PSR is not targeting scheme fees. It will look at what factors determine their level, but not at whether the fees are excessive (albeit the PSR notes that this may become the subject of future review).
The PSR has also left digital (i.e. non-cash) payment methods other than card payments out of scope. Given that digital payments is a fast developing area, we would expect respondents to have commented on this exclusion. However, given that non-cash payment methods still represent only a small percentage of the total number of transactions, the PSR’s decision to park this for the moment and focus (non-exclusively) on MasterCard and Visa may be justifiable.
Is the PSR looking to protect smaller merchants in particular?
The PSR will certainly focus on how these issues may have a disproportionate impact on smaller merchants, who generally have less negotiating power when it comes to agreeing fees and settlement terms. We would expect the PSR to look at whether the fees charged by acquirers are proportionate to the size of the merchant, and whether the settlement terms being offered to merchants (in particular smaller merchants) represent a good quality service.
How will the PSR assess whether the industry is adequately competitive?
There are currently two or three significant acquirers in the UK market. However, without the benefit of a market review and stakeholder feedback, it is difficult to know whether this impacts negatively on consumers.
We would expect the PSR to look at fees in the round (i.e. not limit its focus to interchange fees) and how these have changed over the past few years. Naturally, we see different fee levels based on transaction volume / value and negotiating leverage. We also see pass-through on scheme fees and numerous sets of fees around FX transactions.
It takes time for new entrants into the market to build up the necessary capabilities and technical support systems. The PSR will be looking at the challenges that they face and what can be done to reduce barriers to entry.
The PSR will also look at data around switching. In our experience, there is a great deal of ‘stickiness’ binding merchants to certain acquirers, arising from from the time it takes to on-board merchants, the use and access to customer data and the number of different types of payment methods the merchant requires globally. This generally means that merchants do not switch between acquirers that often.
Will the PSR wait to see the outcome of the European Commission’s review of the IFR before it decides whether to take action?
The Commission’s review of the IFR (which is due by June 2019) will look at the appropriateness of the levels of interchange fees (taking into account the use and cost of the various means of payments), the level of entry of new players, new technology and the impact of innovative business models on the market.
Its primary purpose is to understand how much it was costing merchants to accept cards before the regulation came into effect on 9 December 2015, and whether overall costs have gone up, down or broadly stayed the same. Their measures won’t be limited to interchange only, but the overall merchant service charge (MSC), which includes card scheme and acquirer fees. No further detail has been published by the Commission on this review, so it is definitely an area to watch.
Whilst the Commission will be looking at these issues from a European perspective, the UK is one of the largest payments industries in Europe. The PSR will no doubt have one eye on what is being done at European level, but ultimately it is concerned with fees charged by UK acquirers only.
Timing is one aspect of the draft ToR that we would have expected the payments industry to comment on, and we may well see a push for deferral of any action by the PSR until after the Commission’ review has been completed.
How do you think merchant acquirers will respond to the draft ToR
Given the importance of a functioning payments system to the whole of the UK market, participants are likely to accept the need to review the market and respond positively. However, the payments industry is a complex market and many acquirers may feel that settlement risk is part of what they are buying, and the fee is just part of that.
We would expect the greatest debate to be around the scope of the review, and we may see the PSR decide to include scheme fees. Arguably, the PSR needs to look at what it is costing merchants in the round, otherwise it is telling only half the story.
What are the likely outcomes of the market review?
There is continued regulatory focus on interchange fees, in particular pass-through, both at UK and European level. Merchants are evidently feeling the squeeze and regulators will be looking at ways of managing that down for merchants. However, fees is not an area in which UK regulators have typically weighed in. It would be odd for the PSR, an economic regulator, to set out prescribed fee levels, particularly given the EU’s remit under the IFR. What we are more likely to see from the PSR are directions aimed at promoting competition through a change in business practices.
When can we expect any changes to be implemented?
The deadline for comments on the draft ToR was 14 September 2018 and the PSR expects to publish the finalised ToR by the end of 2018.
We would expect it to take up to a year for the PSR to review the outcomes, followed by a six- month implementation period. In which case, we would be looking at mid-2020 before any action is likely to be taken.