Thursday, March 27, 2014
On March 21, 2014, a three judge panel at the U.S. Court of Appeals for the District of Columbia Circuit threw out the previous ruling that ordered the Federal Reserve Board to reevaluate the way it implemented debit card regulations mandated by the Durbin Amendment to the 2010 Dodd-Frank Act. The appeals court ruling is seen by industry experts as erasing regulatory uncertainty for a financial services industry grappling with the challenges of transitioning the entire payments infrastructure to the Europay/MasterCard/Visa (EMV) chip card standard.
The appeals court unanimously overturned the July 2013 opinion of Judge Richard J. Leon of the U.S. District Court for the District of Columbia on the grounds that the Fed reasonably interpreted the demands of the Durbin Amendment when it capped debit card interchange fees at 21 cents per transaction and implemented debit routing regulations.
Since the Fed's rules went into effect in October 2011, retailers, retail associations, and even the Durbin Amendment's sponsor, Sen. Richard Durbin, D-Ill., have argued that the Fed misinterpreted Congress' mandate and set the fee cap too high. The National Retail Federation, among others, appealed the Fed's implementation in court, which resulted in Judge Leon's decision. But the Fed appealed that decision, and the court agreed with the Fed.
In the court's opinion, Circuit Judge David S. Tatel wrote that the plaintiffs had a "steep hill to climb" to convince the judges that the Fed's interpretation of the Durbin Amendment was improper. "Congress directed the Board to issue rules that would accomplish a particular objective, leaving it to the Board to decide how best to do so, and the Board's rule seems to comply perfectly with Congress's command," he wrote.
Judge Tatel also denounced merchants' argument that the Fed's debit transaction routing provision that two networks be available for every transaction was anti-competitive and needed to be doubled. On that count, the judge commented, "[F]ar from summiting the steep hill, the merchants have barely left base camp."
While the payments industry was unanimously opposed to passage of the Durbin Amendment in the first place, and retail groups that pushed for the amendment decry how it was implemented, the lines of disagreement are still clearly drawn.
NACS, the convenience store association and chief plaintiff in the retailers' appeal, was not pleased with the judges' opinion. "It is unfortunate that the D.C. Circuit Court of Appeals misread the law and the Federal Reserve's rule on debit swipe fees," said NACS President and Chief Executive Officer Henry Armour. "Any rule that would allow profit margins of more than 1,000 [percent] and raise fees on many transactions clearly violates the letter and intent of the law Congress passed."
The NRF agreed. The retail association's chief lawyer, Mallory Duncan, said, "The Fed ignored congressional intent and worked to shield debit card companies and big banks. A self-described victory for the banks usually results in higher costs for consumers."
On the other side of the divide, Electronic Transactions Association CEO Jason Oxman said the best part of the D.C. court's decision was the "prospect that the financial industry and merchants can move past this longstanding litigation and resume our focus on providing the best possible services to consumers."
Boston-based consultancy Mercator Advisory Group analyzed the ruling from both debit and prepaid card angles. Ben Jackson, Senior Analyst, Prepaid Advisory Service, at Mercator, said Judge Leon's decision did not materially affect the prepaid card industry, because exemptions to the interchange cap provision given to prepaid card providers were left untouched.
However, if Judge Leon's decision had stood and the Fed was forced to expand its network routing mandate to having four networks available on every transaction, the prepaid card industry would have been under the gun, according to Jackson. He revealed that major network operators had "not done much to enable dual signature networks on cards." Therefore, "if every open-loop prepaid card were forced to include at least four unaffiliated [routing] networks on the card, the industry would have been under real pressure," he wrote.
Meanwhile, Ron Mazursky, Director of the Debit Advisory Service at Mercator, said the renunciation of Judge Leon's decision allowed debit card issuers to breathe a "sigh of relief" as it concerned the complicated transition to EMV. The possibility that debit card interchange fees would be lowered even further, and that more routing options would be required, had reduced the industry "to a relative standstill regarding implementation of EMV on debit cards," he stated.
Mazursky said some issuers claimed that lowering debit card interchange further would put their programs in the red. He further noted that Judge Leon's requirement that merchants be given the choice between two PIN and two signature debit networks for the routing of each debit card payment "created problems" for EMV implementation.
"Payment networks have noted that debit issuers were awaiting the appeals court ruling to decide whether to move ahead with the higher cost EMV or delay the EMV decision based on a longer term evaluation," Mazursky wrote.
Payment consultant Paul Martaus agreed with this assessment, but went further. "If [Judge Leon's] judgment had been upheld, it would have forced every card on the planet to be redesigned and reissued," he told The Green Sheet. "Trillions of dollars worth of effort to bring EMV up to date would have gone for naught because what he demanded in his ruling was technologically impossible given the current state of card technology."
Martaus believes the Durbin Amendment was misguided from the start, because lawmakers and even regulators did not understand how the payments industry functions. He said his conclusion is supported by the fact that the amendment focused on interchange rather than the discount rate, of which interchange is just one component. "They did not put a cap on discount because they mistakenly thought that interchange was the culprit," he said.
Martaus noted that many ISOs have taken advantage of this shortcoming in the amendment by offering retailers a "blended" rate that allows ISOs to pocket bigger fees despite a reduction in interchange.
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