Card usage continues to rise, accelerated by the COVID-19 pandemic and the ‘cost of cards’ (i.e. fees associated with the use of card schemes) is a hot topic on the political and regulatory agenda. The Payment Systems Regulator (PSR, economic regulator for payment systems in the UK) has made public statements this year that the fees associated with the card schemes have increased significantly (See for example Q6 to Q35 of the Treasury Committee Oral Evidence: The work of the Payment Systems Regulator, HC 144 https://committees.parliament.uk/oralevidence/10320/pdf/).
In the medium to longer term, the PSR’s plan for ensuring card fees are at reasonable levels is to introduce more competition between payment systems in the UK:
“… we are also taking steps to address some of these competition issues at more of the structural level. That will take some time, but, at that structural level, we want to make account-to-account payments, using, essentially, payments direct from your bank account, a much more credible alternative...” Chris Hemsley, PSR, May 2022 (Answer to Q17 of the Treasury Committee Oral Evidence: The work of the Payment Systems Regulator, HC 144 https://committees.parliament.uk/oralevidence/10320/pdf/)
This is one of the main drivers behind the New Payment Architecture Programme (NPA), being run by Pay.UK. The NPA programme aims to upgrade the current interbank infrastructure in the UK with up-to-date technology, enabling (amongst other things) real-time payments (Pay.UK Strategy, Our Foundation for the future 2021-2026, page 7). A number of the Open Banking initiatives are also aimed at driving account to account transactions.
However, NPA is a couple of years off and policy makers and the PSR are concerned with card costs now. This was highlighted by the questioning in the Treasury Committee of 25 May this year, where MPs asked the PSR several probing questions on how and when card costs would be addressed in the meantime (before NPA launch) (See for example Q6 to Q35 of the Treasury Committee Oral Evidence: The work of the Payment Systems Regulator, HC 144 https://committees.parliament.uk/oralevidence/10320/pdf/).
As expected, based on this policy backdrop, on 21 June 2022 the PSR published the terms of reference (ToR) for two market reviews into the fees charged/set by card schemes in the UK. The two reviews cover:
- Scheme and processing fees: these are the fees paid to the card schemes by card issuers (such as banks) and card acquirers, whenever a transaction is made using a card. This review, follows the PSR’s card acquiring review, which concluded that scheme and processing fees had ‘increased significantly’ between 2014 and 2018.
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- Cross-border interchange fees: these are fees which, in line with card scheme rules, are transferred from the card acquirer to the card issuer, whenever a transaction is made using a card. Prior to Brexit, interchange fees were subject to price regulation. But, due to how the regulation was rolled over to the UK, interchange on cards issued in the European Economic Area (EEA) but used to buy goods from a UK merchant, where the card is not present (CNP, i.e. online or over the phone) have not been subject to price regulation. Interchange on a CNP transaction, with an EEA issued card to a UK merchant, have since seen fivefold increases in price - from 0.2% and 0.3% to 1.15% and 1.5% for debit and credit cards, respectively (Para 1.13 of the PSR ToR).
Based on our experience working on PSR market reviews, as well as similar reviews by the Financial Conduct Authority (FCA) and the CMA, the PSR’s reviews will involve extensive information gathering and analysis by PSR economists and lawyers to understand, amongst other things:
- Effectiveness of competition between payments systems – both between the card schemes and between cards and other payments systems. This will include market share analysis, switching data, review of internal documents around discussions with key customers etc.;
- Whether price increases were justified due to changes in costs, risks and/or the value to customers (e.g. via the merchant indifference test, used for the existing price caps on interchange);
- How prices charged compare to competing products and international benchmarks; and
- The degree of pass-through i.e. the impact that the fee changes for direct users of the card schemes systems have on merchants and end consumers.
Over the course of the reviews, the PSR will use this information and analysis to form a review on what action (if any) is appropriate. The PSR will likely engage with the industry through, interim publications and consultations, meetings and information requests, as it forms this view. The PSR will set a full timetable, including key milestones, in Autumn 2022 (The timetable for previous reviews has varied significantly – the Card Acquiring Market Review, published draft ToRs in July 2018 and Final Report in November 2021; the Infrastructure Market Review published draft ToRs in March 2015 and Final Report in July 2016).
Should the PSR conclude that competition is not working well and that, in turn, market outcomes such as the level of fees need addressing, there are a range of possible outcomes, including the following:
- Recommendations to policy makers e.g. extending the price regulation to cover cross-border interchange, where CNP
- Carrying out an investigation into a potential breach of the Competition Act 1998, for example due to excessive pricing concerns
- A referral to the Competition and Markets Authority (CMA) for a market investigation, where the CMA has wide ranging powers
- Requiring changes to card scheme rules
Whilst fees charged/set by the card schemes are the focus of the reviews, players across the payments ecosystem would see their bottom-lines impacted by changes in the level of scheme/processing fees and cross-border interchange. For example, a retail bank would see changes in its input cost base, if scheme fees were lowered but a reduction in revenue, when its retail customers transact with a card, should interchange levels be reduced. As customers of the schemes, banks and other players may also receive direct information requests from the PSR
Firms may therefore wish to start collecting relevant internal data and documents, undertake an initial review of this information and develop a strategy for engaging with the PSR during the reviews.
Finally, the two studies will encourage a deep dive into the economics of payment systems by industry stakeholders, at a time of rapid change and disruption for the industry. The studies therefore represent an opportunity for firms to consider their forward-looking strategy in payments, in light of the economics of the market(s) and the policy agenda.