A Variation to the Surcharging Standards:
Final Reforms and Regulation Impact Statement – June 2012
2. Background and the Current Issue
The Removal of No-surcharge Rules
In 2003, the Bank began implementing reforms to the credit and debit card systems in Australia. These reforms were intended to improve the efficiency of the payments system and to promote competition. As part of these reforms, the Payments System Board required the removal of a number of restrictions that had been placed on merchants by the international card schemes, including the no-surcharge rule that had prevented merchants from surcharging for credit card and scheme debit card transactions. Accordingly, the Bank imposed standards requiring the removal of no-surcharge rules from 1 January 2003 in the MasterCard and Visa credit card systems and from 1 January 2007 in the Visa Debit card system.[4] American Express, Diners Club and MasterCard (for the Debit MasterCard system) provided voluntary undertakings to remove their equivalent rules.[5]
Paragraph 8 of the surcharging Standards for the MasterCard and Visa credit card systems specifically provides that:
Neither the rules of the Scheme nor any participant in the Scheme shall prohibit a merchant from charging a credit cardholder any fee or surcharge for a credit card transaction.[6]
This wording of the Standards is quite open-ended, providing merchants with the freedom to set surcharges without constraint. At the time the Standards were put in place, the Bank was of the view that this level of discretion for merchants was appropriate – the environment was one where surcharging was likely to develop slowly, given the expectation by cardholders, built up over many years, that surcharges would not apply. It was therefore unlikely that merchants would use surcharging to recover significantly more than the cost of acceptance.
Nonetheless, paragraph 9 of each of the Standards expressly provides that agreements between merchants and acquirers to limit the size of any surcharge to the fees incurred by the merchant would not be inconsistent with the Standards:
Notwithstanding paragraph 8, an acquirer and a merchant may agree that the amount of any such fee or surcharge charged to a credit cardholder will be limited to the fees incurred by the merchant in respect of a credit card transaction.[7]
Together, these elements of the Standards imply an expectation that surcharges would generally be in line with acceptance costs, but that it would be open to the merchant to apply higher surcharges and equally open to acquirers to attempt to bargain surcharges down to the fees incurred. It has become apparent over time, however, that paragraph 9 – the provision allowing agreement to limit surcharges to the fees incurred – has had limited use, and has therefore been ineffective. This is because acquirers for the four-party card schemes (as opposed to the schemes themselves) do not have an incentive to limit merchant surcharges in exchange for reducing merchant service fees.[8] In fact, the opposite can be true since a surcharge may increase the merchant fee the acquirer receives.
Overall, the purpose of the Standards was to introduce more market discipline into negotiations between merchants and acquirers over merchant service fees and, to the extent that merchants surcharge, improve price signals facing consumers choosing between different payment methods.[9] This would lead to a more efficient allocation of resources in the payments system, which is in the public interest. In particular, to the extent that there are payment methods that are more costly for merchants to accept, the merchant would have the power to surcharge for transactions using those payment methods. The consumer, in turn, would have the incentive to avoid using the more expensive payment method if they did not consider that they were receiving sufficient benefit from that payment method.
Indeed, there is evidence to suggest that consumers are responding to price signals brought about by the original reforms by avoiding surcharges where possible. According to the Bank's 2010 Consumer Payments Use Study, consumers paid a surcharge on just 5 per cent of their credit card transactions over the one-week period that the study was conducted, and this proportion was little changed from a similar study conducted in 2007, despite the greater prevalence in surcharging at the time of the later study.[10] In addition, the study specifically asked consumers how they would react when faced with various surcharging scenarios. Across the scenarios, the results suggest that around half of consumers that hold a credit card would seek to avoid paying a surcharge by either using a different payment method that does not typically attract a surcharge (debit card or cash) or going to another store.
Past Review of Surcharging Arrangements
The Bank reviewed the no-surcharge Standards as part of its broader review of the card payment reforms in 2007/08.[11] During consultations for the Review, some industry participants expressed concerns about surcharging being exploited by merchants with market power. Reflecting these concerns, the Board considered whether there was a case for allowing a cap on surcharge levels.
The arguments for and against capping surcharges were finely balanced, with the Payments System Board deciding at the time that the instances of high surcharges were isolated and did not provide sufficient grounds to allow the card schemes to impose restrictions on all merchants. Specifically, the Board was of the view that the imposition of a cap could limit merchant flexibility and potentially remove a negotiating tool for merchants who might agree to limit the amount of their surcharge in exchange for a lower merchant service fee. The Board also assessed that the isolated cases of considerably higher surcharges were more likely a reflection of the market power of the merchants concerned. Further, a confidential submission by one of the card schemes to the 2007/08 review provided the results of a survey that indicated that, at the time, surcharges tended to be set with reference to merchant service fees.
Recent Concerns about Surcharging Practices
Although the Bank believes that the surcharging reforms have been successful and provide significant public benefits, over the years since the 2007/08 review of the payments system reforms, it has become concerned that in some instances surcharging has developed in a way that potentially distorts price signals, thereby reducing the effectiveness of the reforms. In particular, the Bank has been concerned about cases where surcharges appear to be well in excess of acceptance costs – referred to hereafter as ‘excessive’ surcharging – and an apparent tendency for surcharges to be ‘blended’ across card schemes (often at a rate that is higher than the cost of acceptance for the lower-cost card scheme). Both these practices are inefficient because they can cause consumers to underutilise a particular payment method. These practices, which were also discussed in the earlier papers Review of Card Surcharging: A Consultation Document (June 2011 Consultation Document) and A Variation to the Surcharging Standards: A Consultation Document (December 2011 Consultation Document), are discussed in more detail below.
The importance of ensuring that the regulatory framework delivers efficient outcomes is underscored by the size of this part of the payments system, with the value of purchase transactions on scheme credit and debit cards amounting to around $280 billion in 2011.
Excessive surcharging
In recent years, concern has been expressed to the Bank that some merchants may be using surcharging as an additional means of generating revenue, rather than simply covering the costs of card acceptance. A similar conclusion was reached in a report published by CHOICE in November 2010, commissioned by the New South Wales Department of Fair Trading.[12] Survey data by East & Partners also suggest that, for merchants that surcharge, the margin by which the average surcharge exceeds the average merchant service fee has been increasing in recent years; currently the margin is around 1 percentage point for American Express, MasterCard and Visa credit and charge cards, and around 1.9 percentage points for Diners Club cards (Graph 1).
As part of its analysis for the December 2011 Consultation Document, the Bank sought its own data on the distribution of merchant service fees and surcharges to assist in its understanding of the prevalence of excessive surcharging. Specifically, the Bank obtained detailed confidential data from several acquirers on the distribution of merchant service fees for credit cards across their entire merchant books. It also collected a sample of published surcharges from merchants across a range of industries. These data are broadly consistent with the East & Partners survey; for example, the average surcharge on MasterCard and Visa cards was 1.9 per cent, comparable with that of the East & Partners sample. Importantly, the Bank's own data collection also suggests that the observed distribution of surcharges is not entirely consistent with the data on merchant service fees. In particular, even allowing some amount for the other costs of card acceptance discussed below, the proportion of merchants imposing high ad valorem (i.e. percentage) surcharges appears surprisingly high given the distribution of merchant service fees.[13] For example, around 10 per cent of those merchants identified as surcharging Visa and MasterCard credit cards had surcharges of 3 per cent or more; the average merchant service fee for these cards (across all transactions) is around 0.8 per cent.
There is also evidence to suggest that there are certain industries or payment channels where surcharging well in excess of merchant service fees is quite common. These industries and channels also tend to be those where the proportion of merchants that surcharge is quite high. The Bank identified a range of industries where it is common for merchants to impose high ad valorem surcharges, including: accommodation and travel; entertainment, leisure and recreation; hospitality; professional services; rental, hiring and transport; restaurants, dining and takeaway; retail; taxis; and telecommunications and internet. In addition, data from a survey conducted by the Bank in 2010 suggest that the incidence of surcharging is much higher for online purchases than those made in person; respondents paid a credit card surcharge on around 18 per cent of transactions made online compared with 4 per cent of those made in person.[14] A related concern is that often these surcharging industries or merchants are ones for which there are few genuine alternatives to payment by a credit or scheme debit card.
Blended surcharging
The second of the Board's concerns is based on the evidence in the Bank's survey showing the relatively common use of blended surcharging; that is, where cards across different card schemes are surcharged at the same rate despite the fact that there may be significant differences in acceptance costs. For instance, a merchant may apply the same surcharge for American Express, Diners Club, MasterCard and Visa cards even though the merchant's acceptance costs are likely to be higher for some cards than others. In the Bank's survey of merchants, among those merchants for which surcharge rates for American Express, MasterCard and Visa could be identified, nearly 30 per cent charged the same rate across the three schemes. While some merchants may prefer the simplicity of applying only one blended surcharge across card schemes, this practice dulls price signals to consumers about the relative costs of different card payment systems. Specifically, cardholders have an incentive to use a higher-cost card system (which is able to fund more generous rewards than a lower-cost system) more intensively if surcharges do not reflect relative costs.
A related issue is that there appear to be few, if any, instances where merchants apply different surcharges for different cards within a card scheme (i.e. ‘differential’ surcharging). For instance, given that platinum/premium cards can be more costly for some merchants to accept than standard or gold cards – either immediately or subsequently as merchant service fees are adjusted over time to reflect the mix of card transactions – it might be expected that differential surcharging within a scheme would be more common than is currently the case.
The structure of pricing of card acquiring services to merchants may, in part, be contributing to the lack of take-up of differential surcharging. Discussions with merchants and acquirers suggest that many merchants pay a single blended merchant service fee to their acquirer. This single rate often covers all MasterCard and Visa credit and scheme debit card transactions; hence, merchants receive little information about how their card transaction mix influences their blended merchant service fee. In some cases, merchant acquirers also offer ‘interchange-plus’ pricing where each card transaction is priced at the interchange fee plus the acquirer's margin. In contrast to blended pricing, interchange-plus pricing is more transparent, but merchants and acquirers have indicated that, up to now, only a small number of merchants receive interchange-plus pricing.[15]
The Board's assessment of surcharging practices
Based on available data, views expressed in the Bank's extensive consultation rounds on surcharging and research undertaken for government agencies (i.e. the CHOICE report commissioned by the New South Wales Department of Fair Trading), the cases of excessive surcharging are more widespread than at the time the Board last considered the case for limiting surcharges at its 2007/08 review. The existence of excessive surcharging though, is inconsistent with the original intention of the surcharging reforms, which was that ‘… the price signals facing consumers choosing between different payment instruments would lead to a more efficient allocation of resources in the payments system … ’.[16] The effectiveness of the price mechanism, as intended by the original surcharging reforms, is crucial to efficiency in the payments system and the broader reforms to card payments that have been undertaken by the Bank over the past decade. Specifically, the transmission of accurate price signals to consumers is expected to be an effective discipline on acceptance costs over the long run. However, the effectiveness of this price mechanism in this context depends on the extent to which surcharging practices reflect the cost of acceptance of alternative payment instruments; surcharges in excess of the cost of acceptance are inefficient since they can cause consumers to underutilise a particular payment mechanism. In a highly competitive environment, merchants would not be able to surcharge excessively, and so this source of inefficiency would not arise.
As discussed below, the Bank has a legislative mandate for efficiency and competition in the payments system. Although there are other regulations relevant to surcharging, these alone are not sufficient to address the Board's concerns about efficiency in the payments system; instead, their focus is on consumer protection issues and increasing transparency of surcharging. For example, the Australian Competition and Consumer Commission (ACCC) and the Australian Securities and Investments Commission (ASIC) have published a guide on the disclosure of surcharges for merchants that choose to surcharge: ‘Merchant Pricing for Credit Card Payments’.[17] The guide provides that any surcharge should be clearly disclosed before the customer enters into the transaction and that the merchant should not mislead customers about the surcharge (e.g. by claiming it is recovering the merchant fee when in fact the surcharge is higher than the merchant fee). Similarly, the Australian Consumer Law requires that any fee or charge (including a card surcharge) that is unavoidable be incorporated into the advertised price.
While the Board supports measures to increase transparency of surcharges, it is unlikely that these regulations will, on their own, ensure the transmission of accurate price signals. It is in this regard that the Board undertook a review of its original surcharging Standards and decided to relax its current regulations.
Footnotes
The applicable standards are titled: Standard No. 2, Merchant Pricing for Credit Card Purchases; and The ‘Honour All Cards’ Rule in the Visa Debit and the Visa Credit Card Systems and the ‘No Surcharge Rule’ in the Visa Debit System. [4]
It is important to note that the Bank has not had to address this issue in most other payment systems to date, such as the designated eftpos system, because there have not been any rules imposed in these systems that prevent merchants from surcharging. In 2008 and 2009, the Bank investigated the no-surcharge rules in the PayPal system, but decided at that time that the benefit of regulation would not outweigh the costs: see Reserve Bank of Australia, ‘Payments Systems Issues’, Media Release No 2009-03, available at <https://www.rba.gov.au/media-releases/2009/mr-09-03.html>. [5]
The wording of the Standard for the Visa Debit system is similar. [6]
The wording of the Standard for the Visa Debit system is similar. [7]
The MasterCard and Visa schemes are often referred to as four-party schemes because there are four parties involved in the transaction: the acquirer, the cardholder, the issuer, and the merchant. By contrast, American Express and Diners Club are often referred to as three-party schemes because the transaction has traditionally involved three parties: the cardholder, the merchant, and the scheme, which is both the acquirer and the issuer. [8]
Merchant service fees are the fees (typically a percentage of the value of transactions) that the merchant pays to the financial institution (known as the acquirer or acquiring bank) that provides them with card acceptance facilities. [9]
As part of the Payments System Board's Strategic Review of Innovation in the Payments System, the Bank commissioned Roy Morgan Research to conduct a study of payment patterns. The 1 241 individuals participating in the study were asked to record details of every payment they made during one week, including whether they paid a card surcharge on the payment. See Bagnall J, S Chong and K Smith (2011), ‘Strategic Review of Innovation in the Payments System: Results of the Reserve Bank of Australia's 2010 Consumer Payments Use Study,’ June. Available at <https://www.rba.gov.au/publications/consultations/201106-strategic-review-innovation/results/>. [10]
Reserve Bank of Australia (2008), ‘Reform of Australia's Payments System: Conclusions of the 2007/08 Review’, September. Available at <https://www.rba.gov.au/payments-system/reforms/review-card-reforms/pdf/review-0708-conclusions.pdf> [11]
CHOICE (2010), CHOICE Report: Credit Card Surcharging in Australia, November. [12]
The distribution of the Bank's cross-section of surcharges is consistent with distributional data on surcharges provided to the Bank confidentially by East & Partners. The average surcharge for MasterCard and Visa credit card transactions was also in line with the average surcharge from the East & Partners research. [13]
Bagnall J, S Chong and K Smith (2011), ‘Strategic Review of Innovation in the Payments System: Results of the Reserve Bank of Australia's 2010 Consumer Payments Use Study,’ June. Available at <https://www.rba.gov.au/publications/consultations/201106-strategic-review-innovation/results/>. [14]
Some acquirers have also indicated that they offer a third type of pricing to merchants – ‘semi-blended’. This is where card transactions are grouped into a few categories. For example, the merchant might pay two different merchant service fees: a higher rate for ‘premium’ transactions; and a lower rate for ‘standard’ transactions. [15]
As set out in the Gazette notice dated 26 August 2002, in the summary of the purpose and effect of Standard No. 2. Available at <https://www.rba.gov.au/payments-system/legal-framework/standards/pricing-cc-visa.pdf>. [16]
See <http://www.asic.gov.au/asic/pdflib.nsf/LookupByFileName/news_for_business.pdf/$file/news_for_business.pdf>. [17]