By Patti Murphy
The Takoma Group
Interchange. There is probably nothing else in this business that can evoke such visceral reactions. It's been the subject of lawsuits, a multimillion dollar media campaign, proposed legislation and now the U.S. Government Accountability Office has been asked to render an assessment. Even the daily blog favored by political junkies, Politico.com, has caught on to the buzz over interchange.
"It's a fight that has both sides blaming industries that everybody loves to hate," Politico.com staffer Chris Frates wrote in an article concerning the congressional debate over interchange. The article, entitled "On credit card fees, blame game begins," was published in mid-July 2008.
"The merchants have tried to paint the fees as gouging by greedy credit card companies, which, in turn, have charged oil companies with skimming money from their retailers," Frates noted. "It's a classic Washington story: two major industries fighting over the bottom line.
"One thing both sides agree on is that the battle is over far more than the [interchange] paid by gas stations." Three members of the U.S. Senate Small Business and Entrepreneurship Committee wrote the GAO, a congressional watchdog agency, on July 31, 2008, requesting an investigation into the structure and transparency of card interchange.
"The complexity of interchange markets, and the fact that any regulatory or legislative changes will significantly impact both credit card companies and small merchants, makes it prudent that we seek the GAO's assistance on this issue," the letter stated. It was penned by committee members Benjamin L. Cardin, D-Md., Olympia J. Snowe, R-Maine, and Tom Harkin, D-Iowa.
The senators asked the GAO to investigate several aspects of interchange, including its impact on small merchants and the extent to which interchange is addressed by current federal antitrust law.
Interchange has been around since banks first began swapping bankcard information across the Visa Inc. and MasterCard Worldwide authorization and settlement networks. The current debate, however, arises from two separate but equally defining events. One of these was legal; the other was economics.
The out-of-court settlements MasterCard and Visa agreed to on the eve of what was expected to be a prolonged court battle over lawsuits brought by Wal-Mart Stores Inc. and millions of other merchants, came first. Those lawsuits challenged what were then card Association rules requiring merchants accepting any type of MasterCard or Visa card, a bank issued credit card, for example, to also accept all other MasterCard and Visa cards, such as bank-issued debit cards.
The "honor all cards" rules were scrapped under the settlement, although most merchants today accept all types of MasterCard and Visa cards. Plus, Visa and MasterCard pledged to pay a combined $3.1 billion for distribution to merchants for alleged overcharges on interchange for credit and signature debit card payments accepted between 1992 and 2003.
The settlements triggered a flood of new lawsuits, including one well-publicized (and still pending) suit filed by a platoon of small merchants asserting that interchange is a hidden tax on merchants and by extension is responsible, at least in part, for rising consumer prices.
Emboldened by their successes on the courthouse steps, merchants and their allies began lobbying Congress, and earlier this summer the U.S. House Judiciary Committee approved legislation titled the Credit Card Fair Fee Act. The legislation would create an exemption to federal antitrust laws to allow merchants to negotiate interchange directly with Visa and MasterCard.
The House bill doesn't have much of a chance for passage, given the dearth of congressional working days between now and the November elections. But if the request to the GAO from the Senate Small Business Committee is an indicator, lawmakers aren't apt to let this issue pass without further debate.
The second defining event has been the economic downturn that began in 2007, marked by triple-digit increases in cost of fuel oil.
"If you are concerned about prices at the pump, you need to be concerned about interchange," Tom Robinson, President of San Jose, Calif.-based Robinson Oil Co., told members of the House Judiciary Antitrust Task Force in May.
Robinson Oil, which runs a small chain of gas stations in California, is a member of the National Association of Convenience Stores, a Washington-based trade association with deep pockets. The NACS spent $1.5 million in 2007 on lobbying efforts, according to government documents.
In addition to its own efforts, the NACS has joined forces with more than a dozen other retailer-oriented trade associations under the banner of the Merchants Payments Coalition. As prices at the pump set records this year, MPC and its members have seized upon the opportunity to portray interchange as a consumer issue.
According to the Center for Responsive Politics, a public interest group that tracks spending by lobbyists, MPC shelled out $177,500 lobbying Congress and the public for changes in the interchange status quo during the first six months of this year. Last year, the group spent $500,000, the center reported.
"Thousands of gas stations are closing nationally due to high credit card fees," proclaimed an MPC press release in the lead-up to the Judiciary Committee's vote on the Credit Card Fair Fee Act. Hoping to drive home the point while Congress is in summer recess, the NACS has developed pump signage for members to display between Aug. 1 and Sept. 6. The pump toppers read: "Tell Congress you want to know how much this fill-up just cost you in credit card fees."
The National Retail Federation's number crunchers estimate the average American family will pay $427 in interchange fees this year, up from $378 in 2007. (The estimates are based on "projected" interchange collections for the year divided by the U.S. Census Bureau's estimate of 112.4 million U.S. households.)
"If consumers knew how much they are actually paying for credit cards, most would say they aren't worth the price," NRF Senior Vice President and General Counsel Mallory Duncan told lawmakers on the eve of the Judiciary Committee vote. "There is no transparency and no negotiation under the current system."
Allowing merchants to negotiate directly with Visa and MasterCard would result in fees "that reflect the actual cost of the services provided," Duncan insisted. It's a message merchants have been pitching to the media, and it's been picked up by several national outlets, including the CNN and ABC News.
The American Bankers Association, has taken strong exception to merchants' legislative ambitions. Rather than helping out consumers, pending interchange legislation "would give merchants windfall profits," the ABA insisted in a statement.
"When merchants choose to accept payment cards, they pay a penny or two on each dollar for the ability to accept electronic payments," the ABA said. "Retailers, while fully aware of the benefits these services provide, now do not want to pay for it. Rather, they want Congress to intervene to lower a cost of doing business." Both Visa and MasterCard have extended helping hands to gas station owners in the wake of spiraling prices at the pump.
Visa announced processing and rate changes for petroleum purchases earlier this summer. "Even though Visa's interchange rates on fuel transactions are already among the lowest in our system, the run-up in fuel prices to today's unprecedented levels requires an exceptional response," Bill Sheedy, Global Head of Corporate Strategy and Business Strategy at Visa, said in announcing the changes.
Merchant groups were less than thrilled. "If Visa is willing to admit that interchange fees are causing added pain at the pump, why won't it admit its role in rising food and other consumer prices?" the NACS complained. MasterCard implemented its own set of adjustments in 2007, capping interchange to the first $50 of gasoline purchases.
Also, both Visa and MasterCard have taken steps to address related retailer concerns, including complaints about the lack of a central point of information regarding interchange and other merchant rules. That information is now available to merchants online.
"Merchants are an essential part of our system and we are deeply committed to addressing their needs," MasterCard Chief Payment System Integrity Officer Joshua Peirez said in testimony before a House Judiciary Antitrust Task Force.
Peirez chided merchants for failing to negotiate lower discount fees with their ISOs and acquirers. (Interchange, remember, is set by Visa and MasterCard and represents the base upon which acquirer, ISO and MLS profit margins are built. Discount fees represent the all-in cost per transaction paid by merchants.)
"The publication of MasterCard's rules and default interchange rates was designed to enhance the merchant's ability to negotiate prices in terms of MasterCard acceptance," Peirez told task force members. The MasterCard executive said gas station owners should use the cap on interchange for gas purchases to negotiate lower fees for acceptance of other card brands.
The original intent of interchange was to compensate card issuers for the costs and risks associated with extending unsecured credit to cardholders. But as the payments landscape changed over the years, so, too, did the business models for bankcard issuance and merchant acquiring.
Perhaps one of the biggest changes came in 2005. That's when Visa and MasterCard began segmenting transactions based on the type of card used, rendering those tied to issuer rewards programs among the most expensive for merchants to accept.
Before then, fees were based primarily on merchant size, industry, card type (corporate versus consumer, for example) and whether cards are available for swiping (card present versus card not present, for example).
While rewards programs encourage shoppers to use their MasterCard and Visa cards, the funding costs can be substantial. The current interchange structure aims to help issuers make up those costs. For their part, merchants complain that they have no control (or ways to distinguish) rewards card transactions from payments made using nonrewards cards.
A key econometric objection to the current interchange model is that it's value- and not cost-based. In a cost-based pricing model, fees should drop as volumes rise and economies of scale are achieved. In the bankcard system, fees are based on a complex set of calculations that assess the value of the service to banks, consumers and merchants.
A Financial Insights July 2008 advisory, on interchange, stated that in many ways, Visa and MasterCard are "victims of their own success" and suggested the potential for competitive alternatives may have never been better.
Financial Insights examined six alternatives to bankcards and concluded none pose a major threat to MasterCard, Visa or banks. "These alternatives face the high-risk-high-reward challenge of capturing a meaningful slice of interchange revenue from the massive and still expanding revenue streams at Visa and MasterCard," the report stated.
The alternatives examined by Financial Insights included several automated clearing house- (ACH) based schemes: card-based ACH settlement (the merchant-sponsored National Payment Card), noncard versions (including PayPal and NACHA - The Electronic Payments Association's Secure Vault Payments) and alternative card models (such as decoupled debit).
A key drawback to the ACH is that it's a batch-processing system and doesn't have the built-in credit risk and fraud detection capabilities, the consultancy noted.
The firm also pointed to several alternative card networks, including STAR, a PIN debit network owned and operated by First Data Corp.; NYCE, a PIN debit network owned by Metavante Corp. that has a notable presence in the Northeast; and China UnionPay.
A 6-year-old venture backed by the Chinese government, CUP claims a domestic membership of 169 banks issuing more than 1.5 billion cards that can be used at about 1.2 million domestic POS terminals. CUP also has aspirations for international expansion.
Debates over interchange have not been limited to the United States. The Reserve Bank of Australia (that country's central bank) has been regulating interchange since 2004. The agency forced reductions in interchange equal to about 40 basis points and eliminated restrictions on merchants surcharging bankcard users.
But according to most reports, any savings generated by the change merely flowed to merchants' bottom lines; there were no perceptible reductions in consumer prices after the central bank slashed allowable interchange rates.This has not escaped the notice of ISOs and others in the acquiring sector.
"In Australia they cut interchange and the merchants didn't pass along any savings," wrote GS Online MLS Forum member 4Core in a recent post on the Forum.
Not that interchange is problem free. "I think the current interchange models need some work, so that everyone can follow it more easily," 4Core added. "I think the complication of reading interchange leads to frustration on the part of merchants."
In December 2007, the European Union's antitrust authority ruled MasterCard's interchange fees were illegal. It took a similar stance with Visa and has been reported to be in negotiations with Visa.
"Multilateral interchange fee agreements such as MasterCard's inflate the cost of card acceptance to retailers," the Commission for Competition Policy complained, adding that "consumers foot the bill."
"Interchange has been mangled and spun to refer to something it is not," wrote MLS Forum member merc in a recent Forum post. Interchange is what acquiring banks pay to issuing banks. "What is at issue here is not interchange. It is your revenue, most directly," merc insisted.
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