By Marc Abbey
First Annapolis Consulting
In October 2015, the long awaited EMV (Europay, MasterCard and Visa) liability shift will arrive for most merchant types in the United States. The least secure party (for example, the issuer or acquirer) will be liable for counterfeit and, in some cases, lost and stolen fraud in card-present environments.
Among the many implications, this shift means acquirers will be in the consumer fraud business, at least until merchants are EMV enabled. It is prudent for acquirers to analyze how their portfolios are impacted; the composition of an acquirer's portfolio is a huge variable driving the degree of risk the liability shift presents.
First Annapolis estimates that, system-wide, the liability shift may result in an increase in exposure for acquirer exposure of 5 to 10 percent overall. This exposure has the character of delayed delivery risk, in a sense. So, for example, if a non-EMV enabled restaurant fails, issuers will be able to charge back counterfeit fraud for the duration of the chargeback window after the failure of the merchant, causing a loss for the acquirer, almost as if that merchant had delayed delivery in its business mix.
Not all merchants present the same exposure. Though the system-wide increase in exposure may be a modest 5 to 10 percent, individual merchant industries can be orders of magnitude higher, driven by the prevalence of consumer fraud in that merchant category. So acquirer portfolio concentrations will determine the risk during the EMV transition. Most acquirers have very limited line of sight to consumer fraud by merchant category because it has been an issuer risk.
A similar variable that will impact acquirer risk is the percentage of non-U.S. cardholders in a merchant's volume. The United States is one of the last markets in the world to migrate to EMV, so a critical mass of the cards issued to non-U.S. cardholders are EMV enabled. First Annapolis' non-U.S. issuing clients seem eager to use the liability shift to charge back applicable fraud to U.S. acquirers. Non-U.S. issuers have long absorbed counterfeit fraud because the United States was a mag-stripe environment, and the fraud rate on non-U.S. issuers' cross-border volume is materially higher than on their domestic volume.
So, for example, according to the European Central Bank's Third Report on Card Fraud published in 2014, cross-border transactions between Single European Payments Area (SEPA) countries (essentially the European Union) and non-SEPA countries were 2 percent of volume but 25 percent of card fraud. Whereas card fraud overall was 3.8 basis points in 2012, the fraud rate on the cross-border volume acquired outside of SEPA countries was 12.5 times higher, all in.
Isolating counterfeit fraud, 40 percent of the fraud in SEPA countries overall was counterfeit, and 65 percent of the counterfeit fraud was on cross-border volume acquired in non-SEPA geographies, a number dominated by U.S. merchants.
Working through the algebra, the counterfeit fraud rate on cross-border volume to non-SEPA geographies was bumping up on 50 basis points in 2012. Without using the phrase "You Americans!," the Central Bank attributed these losses to mag strip environments, of which the United States is by far the largest remaining. A card-present transaction with a non-U.S. cardholder will become a much more risky transaction for the non-EMV enabled merchant in October.
Something like 4 to 5 percent of card volume in the United States is from non-U.S. cardholders, though much is from e-commerce. Among card-present merchants, it will be those catering to non-U.S. customers who are most affected: travel and entertainment merchants and merchants in border areas. The merchant market is highly heterogeneous, and an acquirer's concentration of non-U.S., card-present volume will directly impact the acquirer's transitional risk.
The first, best defense against this sort of risk for acquirers is, of course, to ensure the EMV compliance of the merchant base, and it would certainly be possible to over-invest in managing this risk, which is a temporary phenomenon. However, it is prudent for acquirers to analyze how they will be impacted, and it may prove wise for acquirers to adjust their underwriting, risk monitoring and collateralization tactics to reflect the new market conditions.
Marc Abbey is Managing Partner at First Annapolis and responsible for the Acquiring Practice.
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