Review of Retail Payments Regulation – Conclusions Paper
October 2021 6. Surcharging

6.1 Issues for the Review

The Consultation Paper noted that the Bank and most stakeholders were of the view that the revised surcharging framework put in place following the 2015–16 Review was functioning well. This framework gives merchants the right to levy a surcharge to recover the cost of accepting payments in designated card schemes, with the ACCC having enforcement powers to prevent merchants from surcharging excessively.^[25] The Board has concluded that the current surcharging regime for card payments remains appropriate and will be unchanged following this Review.

The main question the Board considered in relation to surcharging is whether it would be in the public interest for providers of BNPL arrangements to remove their no-surcharge rules. While businesses have the right to apply a surcharge on card payments if they want to, BNPL providers typically have contractual arrangements that prevent businesses from surcharging BNPL transactions. This means most businesses that accept BNPL payments cannot apply a surcharge to help recover the cost of accepting these payments, even though BNPL services are usually more expensive for businesses to accept than cards. The Board's long-standing view is that the right of merchants to pass on costs to users of more expensive payment methods promotes competition and efficiency in the payments system.

6.2 Preliminary assessment presented in consultation

The Board's preliminary assessment outlined in the Consultation Paper was that there may not be a sufficiently strong public interest case for requiring BNPL providers to remove their no-surcharge rules at this time. However, the Consultation Paper noted that the arguments were finely balanced and a case for seeking the removal of no-surcharge rules could emerge before too long if these services were to continue to grow rapidly and become an even more prominent part of the retail payments landscape. Accordingly, the Board's preliminary view was that BNPL no-surcharge rules should be kept under review and the Consultation Paper sought stakeholder views on principles that could potentially be used to help guide future consideration of this issue.

In considering the policy case for removing BNPL providers' no-surcharge rules, the Board took account of a range of factors, including the strong growth in the market, the rapidly growing adoption by consumers of BNPL services and BNPL providers' high merchant fees (compared to other electronic payment methods such as cards). While the available evidence suggested that BNPL services accounted for a material share of online retail payments (particularly in certain segments), BNPL still represented a relatively small share of total transactions in the economy. In assessing the case for regulatory intervention, the Board also noted the possibility that competition from new BNPL services could put downward pressure on BNPL providers' relatively high merchant fees.

The Consultation Paper also noted that no-surcharge rules might, in some circumstances, play a role in supporting the ability of newer providers of BNPL services to compete with more established providers. However, competitive neutrality was also important and differences in regulation should not provide newer players with an unfair competitive advantage in the medium term. The preliminary assessment sought to strike a balance between these two positions.

6.3 Stakeholder views

The majority of stakeholders – including merchants, consumer groups, banks and card schemes – were in favour of immediate policy intervention to remove BNPL no-surcharge rules. Consistent with the view that policy action was urgently required, there was limited support from these stakeholders for reviewing the issue again in the future and the Bank received little feedback on the principles for regulatory intervention outlined in the Consultation Paper. The main arguments in favour of policy intervention were:

• allowing BNPL providers to continue to impose no-surcharge rules creates an uneven playing field in the payments market. That is, no-surcharge rules give BNPL providers an unfair competitive advantage over entities, such as card schemes, that are prohibited from imposing no-surcharge rules on merchants (either by regulation or because they have entered into a voluntary undertaking with the Bank).
• BNPL has become an essential payment offering for many merchants, particularly for online transactions in certain retail segments where BNPL use is widespread. It was argued that the high share of BNPL transactions in particular segments should be given more weight in policy deliberations relative to the BNPL share of economy-wide transactions.
• BNPL is increasing payment costs, particularly for smaller merchants, because use is growing strongly and BNPL is typically more expensive to accept than other payment methods. While merchants may not necessarily choose to surcharge, the right to do so could increase merchants' ability to negotiate lower fees from providers.

In contrast, BNPL providers reiterated their views that the industry is still an emerging and competitive part of the retail payments landscape and remains small relative to the size of other electronic payment methods. These stakeholders argued that, despite rapid growth, merchants have discretion over whether or not to accept BNPL services, and that this exerts competitive pressure on BNPL merchant fees. Some BNPL providers have also argued that they provide a suite of services to merchants – including marketing, customer referrals and fraud protection – in addition to payments processing, and so they argue that it would not be appropriate for merchants to be able to pass on the full cost of accepting BNPL to consumers.

Stakeholder views were mixed on the question of whether competition in the BNPL market was resulting in lower merchant fees. Some stakeholders observed that the influx of newer entrants was resulting in increased price competition and noted that some newer providers tended to charge lower fees than established providers. However, others noted that it was difficult for merchants to stop accepting payments from certain established BNPL providers, some of which reportedly charge relatively high fees, which could dull the effects of price competition. Some stakeholders also argued that removing no-surcharge rules would achieve lower payment costs more quickly than waiting to see how competition in the market plays out.

6.4 The Board's assessment

The merchant's right to surcharge promotes a more efficient and competitive payments system

The Board's long-standing view – which has been supported by developments in merchant service fees over the past two decades (see Graph 1 above) – is that the right of merchants to apply a payment surcharge plays an important role in promoting competition in the payments system and keeps downward pressure on payment costs for businesses. If a business chooses to apply a surcharge to recover the cost of accepting more expensive payment methods, it results in more transparent price signals and may encourage customers to use a cheaper payment option. In addition, the possibility that a customer may choose to use a lower-cost payment method when faced with a surcharge puts competitive pressure on payment providers to lower their merchant costs, and may help merchants in negotiating lower prices directly with their payment providers. By helping keep merchants' costs down, the right to apply a surcharge means businesses can offer a lower price for goods and services to all of their customers and thereby reduce the extent to which users of lower-cost payment methods are cross-subsidising users of more expensive payment methods.

The ability to surcharge can be particularly important for promoting competition between payment schemes in cases where merchants consider it to be essential that they offer a particular payment method to remain competitive – that is, where a business is of the view that it cannot refuse to accept a payment method because it might lose sales to competitors that do so. In this case, the possibility of surcharging can put competitive pressure on payment providers to keep their costs down, where otherwise there may not have been as much pressure.

Data collected by the Bank from 9 BNPL providers indicate that the average BNPL merchant fee was a little over 4 per cent in the June quarter 2021 (Graph 5), which is significantly higher than average merchant fees on card transactions (see Graph 1 above). Some stakeholders have also emphasised that BNPL merchant fees can be much higher for individual merchants, particularly smaller businesses, and that there is considerable variation across BNPL providers. While it is possible that competition from newer providers could result in downward pressure on BNPL merchant fees, it was also observed that competition may take some time to have a meaningful impact on BNPL merchant fees.

BNPL is a rapidly growing and widely used payment method

Stakeholders observed that BNPL has become a popular way of making consumer payments in recent years, particularly in certain sectors. Based on the data provided to the Bank by 9 BNPL providers – including the largest providers in Australia – it is estimated that aggregate BNPL transactions grew by around 25 per cent (by both value and number) over the year to the June quarter 2021 (Graph 6). These BNPL providers processed around 67 million transactions worth $11½ billion in the year. Over a longer period, data from a smaller number of listed providers indicate that the value of BNPL transactions has almost quadrupled over the past three years.

On the basis of overall spending, BNPL accounts for a relatively small share of the payments market in Australia. For example, in 2020/21 the value of BNPL payments was equivalent to 1.7 per cent of Australian card purchases and 3.1 per cent of total retail purchases. However, some stakeholders emphasised that BNPL providers' market shares are much higher for online transactions, particularly in certain retail segments; as noted, many argued this should be given more weight in the policy debate than overall market shares. The Bank estimates that BNPL accounts for about 20 per cent of the value of online retail transactions, which is consistent with estimates cited by some stakeholders on the share of e-commerce transactions accounted for by BNPL. Some stakeholders also noted that transaction shares can be much higher than this in certain segments such as fashion retail, and feedback from merchant representatives indicated that many businesses feel obliged to accept payments from one or more BNPL providers so they do not lose sales to competitors that do offer BNPL as a payment option. A relevant consideration here is that changes in consumer payment behaviour during the COVID-19 pandemic appear to have reinforced the longer-run trend toward retail purchases being made online, where BNPL is a more commonly used and accepted payment option.

The extensive customer and merchant networks of some BNPL providers supports the view that BNPL is now a widely used and accepted way of making consumer payments in Australia. This means that businesses may find it difficult to refuse to accept BNPL; the more consumers that use a particular payment method the more likely a merchant will feel obliged to accept it. And the more merchants that are accepting BNPL, the more likely a merchant will feel obliged to offer it for competitive reasons. According to the Bank's data on BNPL providers, there were 5.2 million active BNPL accounts at the end of June – equivalent to one quarter of the adult population – and 114,000 merchant accounts (Table 2).^[26] It is also worth noting that these merchant figures do not include acceptance of ‘open loop’ BNPL virtual cards, which in some cases are accepted at any merchants that take Visa and Mastercard payments (see below).

Regulation should be applied consistently (competitive neutrality)

The Board's long-standing principle is that regulation should seek to be competitively neutral. A range of stakeholders – including banks and card schemes – have argued that BNPL providers should be required to remove their no-surcharge rules because these rules give BNPL providers an unfair competitive advantage. Entities such as card schemes and PayPal are prohibited from imposing no-surcharge rules on merchants, either by regulation or because they have entered into a voluntary undertaking with the Bank.

Recent market developments have focused attention on the fact that the Bank's policy on no-surcharge rules does not apply consistently to BNPL-type arrangements. In particular, some services with BNPL features have recently been launched by established financial services firms that are subject to the Bank's prohibition of no-surcharge rules, whereas other providers of BNPL services (including the largest providers in the market) are not subject to the same requirements. Inconsistencies may also arise in the application of the surcharging regime to BNPL services using virtual cards, which have become more common. A number of providers now use Visa/Mastercard virtual card arrangements to facilitate in-store transactions at partnered merchants or to enable ‘open loop’ transactions at non-partnered merchants. In principle, merchants would be able to apply a surcharge to the merchant service fee charged by the acquirer on these transactions because they are indistinguishable from ‘regular’ card payments at the point of sale.

While no-surcharge rules may play a role in overcoming barriers to entry in the payments system in some circumstances, this needs to be weighed up against the adverse implications of no-surcharge rules for competition and competitive neutrality. Following the consultation process, the Board has given more weight to the efficiency and competition benefits from a more consistent application of surcharging principles across the payment system. In view of the rapid pace of change in the Australian payments system, these principles should also apply to consumer payment services that may emerge in the future.

However, the Board considers that it may be appropriate to have exemptions for new entrants into the market for a limited time while they establish themselves. This recognises that payments is a network industry in which it can be difficult for new entrants to compete with providers that already have an established network of consumers and businesses. Allowing no-surcharge rules for a short period of time may play a role in supporting the ability of newer providers to compete while they are gaining a foothold in the market.

6.5 Conclusions and recommendation

The Consultation Paper noted that the arguments for and against the removal of BNPL providers' no-surcharge rules were finely balanced. Following the consultation process and further assessment of the policy considerations, the Board has formed the view that the costs of BNPL no-surcharge rules – in terms of efficiency and competition in the payments system – outweigh any potential benefits in terms of supporting the entry of new players into the market. BNPL has continued to grow in popularity and is now used by a significant number of Australian consumers, particularly for online purchases. Accordingly, it is now likely to be difficult for many businesses to decline to accept BNPL services, even if they wanted to, and the high cost of these services is pushing up their payment costs. As noted earlier, BNPL is, on average, significantly more expensive to accept than other electronic payment methods such as cards, particularly for small businesses, which are likely to find it difficult to negotiate lower merchant fees (as is often the case for other payment services). The right to apply a surcharge could have a material effect on the cost of payments for small businesses in Australia. Moreover, in an environment of significant innovation, there are benefits in having a regulatory approach to surcharging that applies consistently across the payments industry.

Removal of BNPL providers' no-surcharge rules would give merchants the option to levy a surcharge on customers who choose to pay with (and benefit from) a BNPL service. However, as is the case for card schemes where surcharging is permitted but many businesses choose not to surcharge, merchants would not be obliged to surcharge BNPL transactions. If a merchant perceives that they benefit from accepting a particular payment method, they may choose not to apply a payment surcharge. As discussed above, the right to surcharge (even if a merchant chooses not to exercise that right) plays an important role in putting competitive pressure on payment providers to lower their merchant costs, and may help merchants negotiate lower prices directly with their payment providers.

The Board has also considered the question of an appropriate approach to determining maximum surcharges – that is, what could be an allowable surcharge on BNPL or any other transactions. In relation to BNPL, the Consultation Paper outlined two possible options. Option 1 was that merchants would have the right to surcharge up to the total cost of acceptance for a particular BNPL service. Option 2 was that merchants would have the right to recover only the ‘payment’ component of a merchant's cost of accepting BNPL payments. Some BNPL providers have argued that option 2 would be conceptually more appropriate because BNPL merchant fees incorporate the cost of a range of services provided to merchants, not just payment processing. However, card schemes and other payment providers currently subject to the Bank's surcharging requirements also provide a variety of services to merchants that are incorporated into the total cost of acceptance. Option 1 would therefore be more consistent with the Bank's current surcharging regime, and would have the benefit of simplicity and transparency. It is also unclear how the ‘payments’ component of BNPL merchant fees could be measured in a context where BNPL (and other payment) providers typically do not provide separate services and prices for the different components of their offerings. Accordingly, consistent with the Bank's current approach to surcharging card payments, the Board's preferred approach is that merchants should, if they choose, be able to recover an amount up to the total cost of accepting payments, including those from BNPL providers. As noted, businesses may choose not to surcharge if they perceive that they benefit from accepting BNPL payments.

In terms of regulation, the Bank's ability to impose standards to achieve this outcome is complicated by the current drafting of the relevant legislation (the PSRA). In particular, while BNPL arrangements facilitate payments between consumers and merchants (just as credit and debit cards do), there is some uncertainty as to whether they meet the legal definition of a ‘payment system’ or whether providers of these arrangements are ‘participants’ in payment systems under the PSRA. The Bank raised this issue in the context of the Treasury Review.^[27] The Bank noted that the payments system had become more complex in recent years and suggested that all entities that play a material role in facilitating payments should be able to be regulated if doing so would be in the public interest as defined in the PSRA.

The Final Report of the Treasury Review was released in August. Among other things, it suggested that “the RBA should be better positioned to regulate new and emerging payment systems that are part of the changing and growing payments ecosystem” and recommended that the PSRA be revised accordingly. At the time of writing, the Treasury was consulting with stakeholders, including the Bank, on the recommendations. The Board supports changes that would clarify the Bank's ability to regulate entities that play a material role in facilitating payments, including in relation to no-surcharge rules. Even with modified regulatory powers, it would remain open for the Bank to seek voluntary undertakings from relevant entities before going down a regulatory route, as the Bank has done in a number of other cases.

A further consideration in this area is the potential interaction between merchant surcharging of BNPL transactions and the National Consumer Credit Protection Act 2009 (NCCPA) administered by ASIC. BNPL services often have one or more features that result in them falling within regulatory exemptions from the NCCPA, as set out in the National Credit Code in Schedule 1 to the NCCPA. Some stakeholders are of the view that if merchants were to levy a surcharge on consumers who use BNPL services, it could result in the BNPL provider no longer qualifying for certain regulatory exemptions. The potential interaction between the removal of no-surcharge rules and ASIC's consumer credit regulation points to the benefits of considering the regulation of BNPL holistically.

The Bank will continue to work with Treasury in an effort to put in place regulatory arrangements that are competitively neutral, put downward pressure on merchants' payment costs and promote efficiency, innovation and competition in the payments system.