Review of Retail Payments Regulation – Conclusions Paper
October 2021 1. Executive Summary

This paper represents the conclusions of the Reserve Bank of Australia's Review of Retail Payments Regulation. The Review commenced in November 2019 with the publication of an Issues Paper that summarised recent developments in retail payments and highlighted a broad range of potential regulatory issues.^[1] After extensive public consultation, the Bank released a Consultation Paper in May that outlined the Payments System Board's preliminary views on the major issues and presented a draft set of standards for consultation.^[2] The Bank again consulted extensively with a wide range of stakeholders and is now releasing the Board's conclusions and a final set of standards which, in the opinion of the Board, will contribute to a more efficient and competitive payments system.

The Bank's Review has coincided with the Treasury's separate Review of the Australian Payments System (the Treasury Review), which has investigated whether the broader regulatory architecture of the Australian payments system remains fit-for-purpose. The Treasurer released the final report of the Treasury Review in late August, and the Treasury is currently consulting on the recommendations ahead of the Government finalising a response. The Treasury Review noted, as has the Bank's Review, that the Bank's powers to regulate new entities and business models emerging in the payments system were relatively limited. However, the recommendations of the Treasury Review, if implemented, could provide the Bank with additional tools that would have some bearing on the policy actions that might be taken in the future.

A summary of the key conclusions of the Bank's Review is provided below. The changes from the preliminary views set out in the Consultation Paper are summarised in Box A.

1.1 Dual-network debit cards and least-cost routing

The majority of debit cards in Australia are dual-network debit cards (DNDCs), which allow domestic debit payments to be processed via either the domestic scheme (eftpos) or one of the international debit networks (Debit Mastercard or Visa Debit). Least-cost routing (LCR), also known as merchant-choice routing, is functionality that allows contactless (‘tap-and-go’) DNDC transactions at the point-of-sale to be processed through whichever network on the card is less costly for the merchant. This choice can help merchants reduce their payment costs and increase competitive pressure between the debit networks. Indeed, the average cost of accepting debit card transactions has fallen as LCR functionality has been gradually rolled out over the past few years. Given their potential benefits for competition and efficiency in the payments system, the Board has strongly supported the issuance of DNDCs and the provision of LCR functionality to merchants.

At the same time though, the Bank has observed a number of emerging challenges to the viability of LCR over the longer term. One challenge is that technological changes have driven a significant shift away from the use of physical (plastic) cards at the point-of-sale to the use of new ‘form factors’, such as mobile wallets, which is increasing the pool of transactions that cannot be routed. Another challenge to LCR is a number of small and medium-sized card issuers considering issuing single-network debit cards (SNDCs) instead of DNDCs. SNDCs prevent LCR because they only allow payments to be processed through the one debit network on the card. Card issuers considering or choosing to issue SNDCs have pointed to the additional costs of issuing debit cards enabling two networks instead of one. However, some issuers may also be choosing SNDCs in response to financial incentives from the debit schemes, including higher interchange fees on SNDC transactions (interchange fees are the fees set by card schemes that are paid by the merchant's acquirer to the card issuer on each transaction). The Board is concerned that a significant reduction in DNDC issuance would reduce the benefits of LCR for merchants. Over time, this would likely impose significant costs on the payments system and broader economy due to the loss of competitive tension between the debit schemes. The Board considers that policy action to limit the shift to SNDCs is therefore desirable.

In addition, some merchants have alleged that the international schemes have dis-incentivised the take-up of LCR by making preferential ‘strategic’ interchange rates on credit card transactions conditional on the value or volume of a merchant's debit card transactions. While the Australian Competition and Consumer Commission (ACCC) has investigated allegations and taken action into such ‘tying conduct’, there is scope for the Bank to take additional action to prevent any potentially anti-competitive behaviour in this area.

More broadly, given the benefits to date from LCR, the Board has considered whether further policy action is warranted to promote the availability and take-up of LCR functionality for both ‘device-present’ (in-person) and ‘device-not-present’ (online) transactions.

Taking these factors and developments into account, the Bank is adopting the following policy framework for DNDCs and LCR:

1. The Bank expects all debit card issuers with more than $4 billion in debit transactions each year to continue to issue DNDCs. Based on 2020 data, this expectation would apply to 8 issuers that account for around 90 per cent of all debit card transactions. If a lower threshold were to be set to capture more issuers, it is probable that the additional costs imposed on smaller issuers to support DNDC issuance would outweigh the public benefit of more DNDCs on issue.
2. For these issuers, both card schemes on their DNDCs should be provisioned in all form factors that they support, including mobile wallets (where the functionality is also supported by the relevant schemes and mobile-wallet providers). While there is some uncertainty regarding the Bank's regulatory power over mobile-wallet providers, it has begun engaging with those providers that do not currently support the provision of both networks on DNDCs and will be encouraging them to do so. In combination, this will increase the proportion of mobile payments for which consumers have a choice of debit network, thereby increasing competitive tension between the schemes.
3. The Bank's interchange standards will be amended by introducing a 'sub-benchmark' for SNDCs, such that the weighted-average interchange fee on SNDCs from a given scheme must be no more than 8 cents. This will limit the possibility of schemes using interchange rates to incentivise SNDC issuance, which could accelerate the shift towards SNDCs.
4. The Bank expects all acquirers and payment facilitators (which provide card acceptance services to merchants) to offer and promote LCR functionality to merchants in the device-present (in-person) environment. Acquirers and payment facilitators will be expected to report to the Bank on their LCR offerings, and on merchant take-up of LCR, every six months. At this stage, the Board does not see a need for explicit regulatory requirements regarding the provision of LCR. This reflects the progress that has already been made by acquirers and payment facilitators on developing this functionality and the other policy actions being taken to address specific threats to the viability of LCR.
5. The Bank expects all acquirers, payment facilitators and gateways to offer and promote LCR functionality to merchants in the device-not-present (online) environment by the end of 2022. The Bank also expects the industry to follow a set of principles regarding the implementation of LCR in the online environment. These measures address the Board's concern that online LCR could be hindered by some industry participants taking slow, divergent, or restrictive, approaches to its implementation.
6. The Bank will seek voluntary undertakings from the international card schemes that they will not engage in tying conduct. If the schemes are not willing to provide voluntary undertakings, the Bank will consult on the introduction of a new standard to explicitly prohibit such behaviour (separately to this Review). Such a prohibition would supplement competition law, helping to ensure that the debit schemes compete solely on the basis of their debit card offerings, thereby supporting competition in the debit card market.

1.2 Interchange fees

Interchange fees are wholesale fees set by the card schemes that are paid by acquirers to card issuers on each card transaction. They are passed on to merchants and are a significant component of merchants' cost of accepting card payments. Under the Bank's interchange standards, card schemes must comply with interchange fee benchmarks; specifically, the schemes' average interchange fees, weighted by the value or volume of transactions in each interchange category, are required to be below a benchmark of 0.50 per cent for credit cards, and 8 cents for debit and prepaid cards. The benchmarks are supplemented by caps on individual interchange rates, which limit the disparity between fees applicable to larger merchants that can benefit from lower ‘strategic’ rates and smaller businesses. These ceilings are currently: 0.80 per cent for credit cards; and 15 cents, or 0.20 per cent if the interchange fee is specified in percentage terms, for debit and prepaid cards.

The Board's long-held view is that interchange fees should generally be as low as possible, especially in mature payments systems. At present, the Board does not see a strong case for significant reforms to the interchange regulations. The current interchange settings have been in effect for only 4 years and appear to be working well. In particular, the Board does not currently see a strong public policy case for lowering the weighted-average benchmarks or the credit card cap.

However, the Bank has noted an increasing tendency for interchange fees on certain debit transactions at smaller merchants to be set at the cents-based cap. The Board is concerned that this can result in smaller merchants facing unreasonably high costs for some low-value transactions (for example, a 15 cent interchange fee on a $15 transaction is equivalent to 1 per cent of the total value of the transaction). To address this concern without significantly changing the overall interchange framework, the Bank will reduce the cap on debit (and prepaid) interchange fees that are set in cents terms from 15 cents to 10 cents. The schemes will still have flexibility to set a range of interchange rates on different types of transactions, including by making greater use of percentage-based fees. Schemes will also have the ability to restructure their interchange schedules if they wish to minimise the impact of the lower cap on overall issuer revenues.

The Board also sees a case for increasing the transparency of interchange fees on domestic transactions on foreign-issued debit and credit cards. The Bank will amend the interchange standards to require schemes to publish interchange fees on transactions on foreign-issued cards on their websites, which will be a low-cost way of shining a light on these relatively high fees.

1.3 Scheme fees

Scheme fees are payable by both acquirers and issuers to the card schemes for the services they provide. They are a significant component of the costs faced by merchants in accepting card payments (because they are passed on by acquirers), as well as the costs borne by issuers for providing card services to their customers. The Board has held concerns for some time about the opacity of scheme fee arrangements to end-users of the payments system, with some indications that this has allowed for scheme fees to increase over recent years. The opacity could also, in principle, make it easier for schemes to implement fees or rules that may be anti-competitive or have the effect of circumventing the Bank's interchange fee regulation.

Meaningful disclosure of scheme fees could partly address these concerns, thereby improving efficiency and promoting competition in the payments system. At the same time, the Board acknowledges that there is a degree of commercial sensitivity around scheme fees, and that disclosure requirements could increase the compliance burden for the industry. The Board considers that the following approach strikes an appropriate balance between these considerations:

• Schemes will be required to provide the Bank with access to their scheme fee schedules and all scheme rules, and to notify the Bank promptly of any changes to these.
• Schemes will also be required to provide quarterly data on scheme fee revenue and rebates to the Bank. The Bank will consider publishing some of the aggregate data, to provide stakeholders with greater visibility over the average levels and growth rates of these fees across schemes. Larger issuers and acquirers will also be required to provide annual data on scheme fee payments to act as a cross-check on the data reported by the schemes.

1.4 Surcharging

The Bank's existing surcharging rules give merchants the right to levy a fee on customers to recover the costs that merchants face in accepting payments using credit and debit cards. This is supported by rules that prevent merchants from surcharging excessively, which are enforced by the ACCC. While many merchants choose not to surcharge card payments, having the right to do so can help lower their payment costs and promotes competition between card schemes. With the changes that were introduced following the 2015–16 review, the Board considers the current surcharging framework for card payments to be working well and has decided not to make any further changes.

A particular issue for this review was whether businesses that accept payments using ‘buy now, pay later’ (BNPL) services should be allowed to also apply a surcharge to recover the cost of accepting these transactions. BNPL transactions have been growing very strongly in recent years and these services have been adopted by a significant number of consumers and merchants. BNPL services are particularly widely used for certain types of purchases. BNPL services are often free or inexpensive for consumers to use if payments are made on time, but tend to be expensive for merchants to accept. Despite this, providers of BNPL services typically have ‘no-surcharge’ rules that prevent merchants from passing on these costs to the consumers who benefit from using the BNPL service.

The Board considered the argument that no-surcharge rules can promote innovation and competition in the payments system by helping new payment providers build up the consumer sides of their networks. However, this needs to be weighed against the adverse implications for competitive neutrality in an environment where designated card schemes and some other payment services have been required to remove their no-surcharge rules. Moreover, while BNPL still accounts for a relatively low share of overall transactions in the economy, there are indications that its use is now widespread in certain retail segments. Consistent with this, there was strong feedback from merchants that BNPL has become an essential payment offering for many of them and that the high cost of these services was pushing up their payment costs. The ability to surcharge can be particularly important for promoting competition between payment services where merchants consider it essential to accept a particular payment method to remain competitive.

Taking these factors into account, the Board has concluded that it would be in the public interest and consistent with its mandate to promote competition and efficiency in the Australian payments system for BNPL providers to remove their no-surcharge rules, so that merchants have the ability to apply a surcharge to those payments if they wish. This approach is consistent with the Board's long-standing principle in relation to no-surcharge rules.

Given the complexity of the regulatory issues, the Bank will continue to engage with Treasury as part of the Treasury Review to ensure a level playing field in relation to no-surcharge rules and to keep downward pressure on merchant payment costs, especially for small businesses.

1.5 Other issues

The Bank will also implement the following policy actions:

• New initiatives to further improve the transparency of payment costs for merchants, to help reduce some impediments to competition in the acquiring market for smaller merchants.
• Some minor revisions to the net compensation provisions in the Bank's interchange standards, which include formalising recently issued guidance about when and how new issuers should begin certifying compliance with the provisions.
• Revoking the designation of the American Express Companion Card system, given that the four major banks have ceased offering companion cards.

At this stage, no regulatory action in the mobile-wallet market is being proposed. There are important issues to be addressed here, but the Payment Systems (Regulation) Act 1998 (the PSRA) as currently drafted limits the scope for the Bank to address these issues. The Bank's power to regulate mobile-wallet providers, and payment service providers more broadly, will be considered by the Government in its response to the Treasury Review. Until then, the Bank will continue to monitor developments in Australia and overseas closely, and will cooperate with the ACCC where needed to address any policy issues relevant to its mandate.

Box B: Implications of the Review for smaller merchants

During the consultation for this Review, stakeholders representing smaller merchants argued strongly for a range of policy measures to reduce merchants' payments costs. In particular, they advocated for requiring very broad DNDC issuance, combined with a formal regulatory requirement for acquirers to provide LCR to merchants on an opt-out basis, across all payment channels (including mobile and online). Central to their concerns was the low take-up of LCR by merchants, arguing that most merchants were not benefiting from the considerable savings that could be made through LCR. This was occurring at a time when changing payment behaviour – such as the ongoing shift towards contactless, mobile and online payments (and card payments more generally), as well as the rising popularity of BNPL products – was putting upward pressure on smaller merchants' payment costs. Merchant representatives also argued for the removal of the no-surcharge rules that are imposed by most BNPL providers, consistent with the approach that has already been taken by the Bank in relation to card payments.

The Board has carefully considered the submissions that have been made by stakeholders representing small merchants. The measures being implemented in the conclusions of the Review reflect the Board's assessment of how the Bank can best serve the interests of all end users of the payments system – consumers, businesses and government entities – and meet the Bank's mandate to promote the efficiency of the payments system and competition in the market for payment services.

The broad context for the review is that Australia has a relatively low-cost payment system by international standards. The average cost of all card payments has fallen significantly over the past two decades, reflecting the Bank's policy actions starting with the 2003 reforms (Graph B1). And as documented in Box C ‘The cost of debit transactions in Australia’, the average cost of debit card transactions has also fallen in recent years. While international data are limited, the evidence that is available suggests that the cost of debit card transactions in Australia is amongst the lowest in the world, including for small merchants. An illustration of the low cost of payments in Australia is that the average cost of card payments for the smallest Australian merchants is well below the average cost of card payments for all US merchants (Graph B2).

A range of reforms in this Review will benefit smaller merchants by maintaining downward pressure on payment costs. The reduction in the cap on debit interchange fees that are set in cents terms from 15 cents to 10 cents will lower the cost of many transactions for smaller merchants, and narrow the difference between interchange fees paid by small merchants and those paid on transactions at large merchants that can benefit from lower ‘strategic’ rates. In particular, it will lower the cost of some online, mobile and premium debit transactions, given that interchange fees for these transactions are often set at the 15 cents cap by one or more of the debit schemes. This change follows measures taken at the conclusion of the 2015-16 Review, including the reduction in the weighted-average debit benchmark from 12 cents to 8 cents and the introduction of the cap on individual interchange categories, which provided significant benefits to smaller merchants.

The Board's expectations regarding the provision of LCR in the device-present (or ‘in-person’) environment will maintain pressure on acquirers and payment facilitators to offer and promote the functionality, which should increase take-up by merchants and reduce their payment costs. Recent steps by some of the major banks to offer single-rate plans for smaller merchants with LCR implemented in the background and/or provide LCR for smaller merchants on an opt-out basis are a reflection of the heightened competitive pressure on acquirers and will materially increase the proportion of merchants that directly benefit from LCR. The Board's expectations regarding the provision of LCR in the device-not-present (or online) environment should also soon lead to lower payments costs for merchants. It will allow merchants to directly reduce their costs by routing online debit transactions through the cheapest network. But, importantly, the experience with LCR in the device-present environment shows that it will increase the competitive pressure on schemes to also lower their interchange and scheme fees on online transactions, which should flow through to lower merchant service fees (for all merchants).

The Board's decision to seek the removal of no-surcharge rules in BNPL arrangements, consistent with the approach it has taken previously for card payments, would provide merchants with the ability to impose a surcharge on users of BNPL services, which tend to be quite expensive for merchants to accept. This can help reduce merchants' payment costs directly and also serve as a way to exert competition pressure on providers to keep their fees down.

The Board recognises that the complexity of payments concepts and pricing methods makes it difficult for merchants to engage with LCR and compare pricing plans, which is contributing to limited merchant take-up, and acquirers may not always pass on the full savings from LCR to merchants. Accordingly, the Bank will be providing educational and pricing information to merchants to help address these impediments; the Board is also optimistic that the Consumer Data Right will be expanded to include card acquiring services provided to small businesses, which would make it much easier for merchants to compare the pricing of different acquirers, and possibly even to switch acquirers. Combined with the ongoing entry of technology-focused providers and global players into the Australian acquiring market, this should lead to greater competition, increased take-up of LCR, greater pass-through of the savings from LCR, and lower merchant service fees for smaller merchants.