A Variation to the Surcharging Standards:
Final Reforms and Regulation Impact Statement – June 2012 7. Evaluation and Impact Analysis

In making a determination on whether to vary the surcharging Standards under section 18 of the Payment Systems (Regulation) Act, the Bank must consider whether the variation is in the public interest. Section 8 of the Act sets out that in determining whether a particular action is in the public interest, the Bank is to have regard to the desirability of payment systems:

1. being (in its opinion):
   1. financially safe for use by participants; and
   2. efficient; and
   3. competitive; and
2. not (in its opinion) materially causing or contributing to increased risk to the financial system.

The Reserve Bank may have regard to other matters that it considers are relevant, but is not required to do so.

The Bank has considered the public interest in its evaluation of the various options, as well as the potential effects each of these options may have on individual users and providers of payment services, including:

• the institutions that are participants in the credit card and scheme debit systems
• merchants that accept credit and scheme debit cards
• credit and scheme debit cardholders
• consumers and the community as a whole.

The Bank has also taken into account the views expressed by the various parties during the consultation process. The following discussion sets out the Bank's evaluation of the four main options considered.

The Options

Option 1: No modification to the Standards

The Board considers that the removal of card schemes' no-surcharge rules has had substantial benefits, particularly in improving price signals faced by cardholders about the relative costs of different payment instruments. The transmission of more accurate price signals to consumers is also an effective discipline on acceptance costs, which should, over the longer term, place downward pressure on merchant service fees, and potentially interchange fees.

Leaving the Standards unchanged would ensure that merchants continue to have the flexibility to surcharge without any regulatory constraint on the level of surcharges and to therefore continue to use surcharging to aid negotiations over pricing, which may help to place downward pressure on their merchant service fees.

Having an unconstrained capacity to surcharge was important when the Standards were first introduced because it encouraged the take-up of surcharging by merchants. However, this unconstrained capacity may arguably be less relevant in an environment where around one-third of merchants surcharge and the practice is well recognised by the public.^[20]

Another related argument for leaving the Standards unchanged is that any modification might be applied by the schemes in a way that makes it more difficult for merchants to surcharge. The Bank is of the view that an appropriately worded Standard would avoid such an outcome and would help to reinforce the rights of merchants to recover their card acceptance costs.

These potential benefits of leaving the Standards unchanged in their current form, however, need to be weighed against the potential costs. In particular, a significant cost is the potential detriment to the overall efficiency of the payments system in terms of total costs and the allocation of resources if the practices of excessive surcharging and of blended surcharging across card schemes are left unaddressed.

In addition to these effects, the Standards in their current form provide no capacity for consumers to assess, or be confident, that the surcharge they face is reasonable. This potentially limits the ability of consumers to question high surcharges and to place pressure on merchants that are excessively surcharging. While the Bank regularly publishes data on average merchant service fees for the different credit card schemes, it remains very difficult for consumers to assess whether surcharges being imposed by a particular merchant are excessive. As part of the initial consultation on surcharging in June 2011, the Board sought views from the industry on whether such concerns might be addressed by promoting the disclosure of merchant service fees by merchants. This could be one way to provide consumers with information about the cost of card acceptance, against which the reasonableness of any surcharge could be assessed. As reported in the December 2011 Consultation Document, nearly all submissions were strongly opposed to any requirements for disclosure of merchant service fees at the point of sale, citing the fact that merchant-acquirer agreements are subject to commercial confidentiality. A related argument was that the merchant service fee forms only part of a wider set of the costs of card acceptance, so disclosing only one price might not provide an accurate picture. On balance, the Bank is of the view that there would be significant costs to leaving the current surcharging Standards unchanged, with data suggesting that excessive and blended surcharging are now relatively common, while the cost of relaxing the Standards – mainly related to compliance – could be reduced with guidance from the Bank (see below).

Option 1, however, should be further considered in the context of whether the Board's concerns can be addressed by means other than varying the Standards. On this issue, the Bank has considered the possibility of using moral suasion to address inefficient surcharging practices; this was raised in the December 2011 Consultation Document. Under this approach, rather than a variation to the Standards, the Bank would make a public statement clarifying the intent of the Standards (in their current form) – for merchants to pass through an amount to consumers that reflects the cost of card acceptance. The Bank might also provide some specific guidance in its public statement that outlined its expectations for card surcharges to be no more than a certain percentage of the transaction value. By setting expectations about acceptable surcharge levels for merchants and consumers, moral suasion might potentially act as a constraint on inefficient surcharging practices, without the cost of regulatory action. However, moral suasion alone may not be sufficient to change the behaviour of some merchants, particularly those with some market power. In addition, if this were to be done by identifying a specific surcharge level that might be considered reasonable, it could lead to that level becoming the ‘acceptable’ level to which surcharges gravitated, and would not account for the differences in acceptance costs among merchants (see discussion of Option 2). Combined, these possible responses create a risk that moral suasion of this kind might distort price signals, albeit in a different way to the practices of excessive surcharging and blended surcharging across card schemes.

After considering this alternative approach, the Bank remains of the view that varying the Standards is in the public interest and that a relaxation of the Standards would improve efficiency and competition for the payments system as a whole, without contributing to increased risk in the system. Options 2 to 4, below, discuss the various options for doing so.

Option 2: Specific permissible surcharge limit

As discussed above, modification of the surcharging Standards is expected to ensure that the Standards continue to deliver substantial public benefits, particularly in terms of efficient price signals to cardholders and the efficient use of different payment methods. These benefits, however, need to be considered against the costs that are associated with each of the options for varying the Standards, including those that would result if the variation were implemented in a heavy-handed way such that it imposes a costly compliance burden on acquirers and merchants. There would also be costs resulting from the need to renegotiate merchant agreements and notify merchants of the change in card scheme rules.

Option 2 – the Bank setting a fixed permissible cap for surcharges – would provide some benefits over the other approaches to varying the Standards. Specifically, a fixed cap would be transparent for all affected parties, and monitoring compliance with such a fixed cap would be fairly inexpensive and straightforward.

However, this option also has a number of drawbacks flowing from its simplicity. First, the Board would be required to determine an appropriate level for the surcharge limit that would apply for all merchant types and sizes. This level would inevitably be higher than the cost of acceptance for some merchants and might encourage some of these merchants to simply set surcharges at the ‘acceptable’ and apparently ‘endorsed’ fixed limit. For other merchants, however, this level might be set lower than their costs of acceptance meaning that they would be unable to fully recover their costs. Accordingly, this option would lead to inappropriate price signals being provided to cardholders. The second drawback is that if the fixed limit was not adjusted over time, it would be unresponsive to competitive forces that might influence the costs of payments services. Third, if the fixed cap were set to reflect the average cost of card acceptance, it would not allow merchants to differentially surcharge for higher cost cards, and may therefore have the effect of limiting competitive pressure on card costs.

On balance, the Board is of the view that Option 2 is not flexible enough to enable price signals to cardholders to appropriately reflect the relative cost to merchants of accepting different payment instruments. This option may introduce distortions to price signals, separate to those arising from current surcharging practices. The Board therefore favours an approach that is more closely tied to acceptance costs for each merchant, as provided for in either Option 3 or 4.

Option 3: Limit surcharges to a merchant's cost of card acceptance, which would be defined clearly as part of the Standards

Allowing for surcharges to be limited to the merchant's actual costs of card acceptance is, in theory, a relatively clear and straightforward way of achieving the desired outcomes of the variation to the surcharging Standards – to address surcharging practices that distort price signals to cardholders, while still ensuring that merchants can fully recover their costs of card acceptance. The challenge, however, is that in practice there is difficulty in adequately defining the cost of acceptance.^[21]

A simple approach under Option 3 would be to define the cost of acceptance as being equal to the merchant service fee. However, the consultation process highlighted a wide range of other costs that may be associated with card acceptance. Some examples that were suggested by acquirers and merchants during the consultation process were the costs of chargebacks, ‘gateway’ fees, terminal rental, staff training, and communications networks. These costs vary substantially across merchants depending on their size, industry and channel (e.g. point of sale, online). In addition, these suggested costs of acceptance include many that are paid to other providers rather than to the acquirer. For example, some merchants have invested in their own terminals instead of renting them from their acquirer, while some online merchants use a payment gateway separate from their acquirer. In both these cases, defining the costs of acceptance as those charged by an acquirer would limit the ability of the merchant to recover the costs of acceptance on an equivalent basis to other merchants.

Another drawback of this simple approach is that limiting surcharges to the merchant service fee could prompt merchants to ask acquirers to include a wider range of fees in the merchant service fee to allow merchants a higher cap. Alternatively, schemes might put pressure on acquirers to lower merchant service fees (with a corresponding increase in other fees) to try to keep surcharges low.

As an alternative to the merchant service fee, one submission suggested allowing card scheme rules to set a surcharge limit as a specified function of the interchange fee that would apply to the transaction (e.g. a multiple of the interchange fee). This would reduce the incentive for acquirers to manipulate their merchant service fees in order to attract merchants. Additionally, this approach may be more effective in placing downward pressure on interchange fees by creating a direct link between these fees and surcharges; schemes would need to balance the desire to set higher interchange fees with the likelihood of facing higher surcharges for their cards. However, interchange fees are not a particularly good guide to costs faced by individual merchants. In addition, this approach would be difficult for merchants to implement practically (other than those for which a single interchange fee rate applies, such as ‘strategic’ merchants and utilities), because the applicable surcharge limit would depend on each merchant's specific transaction mix.

On balance, the outcomes in terms of price signals and efficiency of the payments system as a whole are likely to be better under Option 3 than under Options 1 or 2 because surcharge limits would vary with the main component of the costs of card acceptance for each particular merchant. However, Option 3 is difficult to practically implement in the Standards because what constitutes the cost of acceptance varies considerably across merchants.

Option 4: Limit surcharges to the reasonable cost of acceptance of cards

Option 4 is a less prescriptive way of tying surcharges to a merchant's cost of acceptance; it would allow card scheme rules to limit surcharges to ‘the reasonable cost of acceptance’ of cards of that scheme. Under this option, the reasonable cost of acceptance would be left largely undefined, though – at a minimum – it would be specified to include the merchant service fee (along the lines provided for in the draft variation to the Standards).^[22]

A key advantage of Option 4 is that it provides the flexibility to allow for different costs to be considered in the reasonable cost of acceptance across different merchants and industries, thereby addressing the concerns mentioned under Option 3 regarding the different types of costs beyond the merchant service fee. This enables surcharges to better reflect the costs of acceptance because the Standards are not prescriptive in what those costs might be. As discussed in the evaluation of Option 3, above, the costs of card acceptance vary widely across merchants of different sizes, different industries and for different channels of payment, which makes it difficult to precisely define these costs for the purpose of the surcharging Standards. For example, as discussed above, some online merchants may have higher costs in processing card payments because they outsource processing to a payment gateway that is separate from their acquirer; under Option 4, this could be reflected under ‘the reasonable cost of acceptance’ while it would be precluded from the other options.

The flexibility of Option 4, however, necessarily affords less certainty for participants. This drawback of Option 4 was noted by a number of participants during consultation. In particular, acquirers, merchants and card schemes expressed concern that there may be lengthy and potentially costly discussions on what are ‘reasonable’ costs to pass on to cardholders. Moreover, some concerns were also expressed during consultation about the possibility of the schemes imposing onerous compliance costs on acquirers and merchants, possibly as a means of discouraging surcharging altogether.

The costs and any uncertainty associated with this option would be largely dependent on how the card schemes adopt surcharging limits in their scheme rules. The Bank's intention is that card schemes do this in a way that imposes minimal burden on all parties concerned. The risk that the schemes might enforce any new surcharge limits more aggressively than intended nonetheless remains. However, the nature of the market may help minimise this risk. In particular, in a four-party card scheme, it is the acquirer that has the relationship with the merchant and negotiates merchant service fees with the merchant. Accordingly, the scheme is not privy to the exact merchant service fee paid or the magnitude of the other costs of card acceptance faced by the merchant. Therefore, the four-party card schemes will have to rely on the assessment of acquirers as to whether or not the surcharge of a particular merchant is excessive. Hence, competition in the acquiring market may assist in keeping the intensity of enforcement in check, as the primary incentive of acquirers is to maintain their merchant relationships, particularly with their larger merchant clients. Furthermore, the schemes will be conscious that the Board is likely to respond if any new freedoms are not being used in the way intended. Indeed, the Bank will be liaising with the card schemes prior to the Standards coming into effect to ensure that they do not impose de facto no-surcharge rules. Both of the four-party card schemes have also indicated that implementation would occur in a way that takes into account the costs and other effects on acquirers and merchants.

As discussed, some submissions noted that the Bank could also help other parties' interpretation of the ‘reasonable cost of acceptance’ by clarifying the costs it considers reasonable. This might be achieved through a guidance note, for example, and would be one way to provide greater confidence that the benefits of the flexibility offered by Option 4 are not outweighed by compliance costs. It would be important that merchant associations were made aware of such a guidance note so that they could broaden its distribution among smaller merchants to ensure that these merchants are aware that they retain the right to surcharge to recoup their costs of acceptance.

Footnotes

East & Partners (2011), Australian Merchant Acquiring and Cards Markets: Special Question Placement Report prepared for the Reserve Bank of Australia, December. [20]

The approach of imposing a limit on surcharges equal to the actual cost of card acceptance is one that has been adopted in the European Union. Specifically, the Consumer Rights Directive prohibits merchants from charging fees that exceed the costs borne for acceptance of a particular payment method, in countries that allow surcharges. However, this Directive will take effect from 2014; hence, there is yet to be an announcement from individual countries on how the limit to actual costs of card acceptance will be implemented. In addition, the European Commission is in the early stages of consultation on the harmonisation of payments regulation in the European Union, including the possibility of limiting surcharges to actual costs. [21]

This document relates to the Bank's Standards under the Payment Systems (Regulation) Act 1998. Merchants also face obligations under the consumer protection framework, including under the Australian Consumer Law, which prevents the levying of a surcharge where there is no alternative surcharge-free payment method. [22]