Review of Retail Payments Regulation – Issues Paper –
November 2019 3. Issues for the Review

3.1 Strategic Issues in the Retail Payments System

During 2010–12, the Board conducted a Strategic Review of Innovation in the Payments System. The Review sought to identify areas in which innovation in the Australian payments system might be improved through more effective cooperation between stakeholders and regulators and to identify possible gaps in the Australian payments system that might need to be filled over the medium term. The outcomes from this Review included the implementation of same-day settlement for direct entry transactions, the formation of the Australian Payments Council, and the development of the NPP.

Among the gaps identified were the ability of end-users of the payments system to:

• make real-time payments
• send more complete remittance information with payments
• address payments in a relatively simple way
• make and receive payments outside normal business hours.

These particular gaps were addressed by the implementation of the NPP, although certain functionality gaps remain for some end-users, reflecting delays in the roll-out of NPP services by some banks. As noted in Section 2.3, the Bank, in collaboration with the ACCC, consulted on functionality and access issues with the NPP during 2018–19.

Drawing on the experience of the 2010–12 Review, the Board considers that it would be useful for the current review to provide an opportunity for stakeholders to identify whether there are further functionality gaps in the retail payments system or broader strategic issues that should be addressed, either in this review or independently of it.^[8] Without limiting responses by stakeholders, these could include:

• the future role of cash. A significant proportion of the population still rely heavily on cash for their daily payment needs. Furthermore, demand for Australia's banknotes is strong and growing, and the evidence suggests it is mostly geared toward legitimate (if non transactional) uses.^[9] Accordingly, cash is likely to play a significant role in the economy for some time to come, which underlines the need for the Bank to invest in keeping banknotes secure from counterfeiting. However, the declining role of cash in household and business transactions is likely to raise some important public policy questions over the next few years. One such issue may relate to maintaining adequate access to cash in the event of a significant contraction in the ATM network or in the provision of other cash services. The Bank invites stakeholders' views on any particular cash-related issues relevant to this review.
• the future of the cheques system. Given the continuing decline in the use of cheques, and the fixed costs involved in the operation of any payment system, it is likely that it will be appropriate at some point for the industry to wind up the cheque system, as long as suitable alternative payment methods are available.
• the future of the direct entry system. Current direct entry arrangements are low-cost, efficient, widely used, and volumes continue to grow (in contrast to the cheques system). However, at some point it may be appropriate to consider whether the enhanced functionality of more modern arrangements (such as the NPP) offer benefits that would justify migration of remaining payments going through the direct entry system. Such a migration will not be under consideration as part of this review, but the Bank would be interested in industry views on the longer-term strategic issues that might arise here.
• capabilities around and management of automated and recurring payments, in particular arrangements for management of direct debits. End-users have periodically noted to the Bank that cancellation or redirection of direct debit and other automated payment arrangements is not always straightforward.
• the impact of new technologies and new entrants. In general, regulation should aim to be technology-neutral and not prevent competition emerging from new players. In some cases, actions taken by regulators may encourage developments in technology (such as support for industry-led initiatives to reduce fraud), or promote access by new entrants (such as establishing access regimes for ATM and card systems). The Bank would be interested in stakeholder views on whether there are aspects of current regulation that should be modified or re-examined in the light of new technology, new players or new business models.
• closed-loop systems and stored-value systems and the role that they play in the payments system, including where they access card or other payment rails, and where they establish their own processes and/or infrastructure. Noting that the Council of Financial Regulators has recently reported to the Government with recommendations regarding stored-value facilities, the Bank would be interested in stakeholder views on regulatory or policy issues arising from closed-loop and other types of stored-value systems, including on whether there are potential approaches to licensing and regulation of non-financial institution payments service providers that would be in the public interest.
• the resilience of the retail payments system. The Board has noted evidence of an increase in retail payment disruptions and stressed the importance of having reliable electronic payment services, especially given the declining use of cash. It endorsed the Bank working with the industry and the Australian Prudential Regulation Authority to develop a standard set of operational performance statistics to be disclosed by individual institutions.
• the increasing importance of cross-border payments, which are typically slower, more costly and more opaque than domestic payments. Retail payments are increasingly crossing borders – for example, businesses providing services to foreign clients or buying supplies from abroad, and individuals sending money overseas or making online purchases from foreign retailers. Some of the additional costs and processing time may partly reflect the additional risks and complexities that need to be managed, but it may be useful to consider whether there are specific efficiency or competition issues that could be addressed.
• the roles played by the range of domestic-focused schemes and frameworks in Australia. As well as the cooperative frameworks managed by AusPayNet for a range of clearing streams and the real-time payments infrastructure managed by NPP Australia, there are domestic schemes for bill payments (BPAY) and debit card transactions (eftpos). There has been a tendency for consolidation of domestic arrangements in some other countries; for example, in the UK, Pay.UK has been established to manage a range of domestic systems and schemes that have been brought together in the New Payments Architecture. The Board invites views from stakeholders on any challenges posed by the various domestic schemes and frameworks in Australia and any changes or consolidation that might be worth considering.
• whether there are opportunities for the use of regulatory technology (‘regtech’) in the Bank's regulatory regime, including whether compliance obligations can be streamlined or made more efficient by the use of regtech.
• possible issuance of an electronic form of banknotes (an eAUD or CBDC for household use). The Bank, like most other central banks, does not consider that there is currently a strong case for this, though it will continue to monitor and review relevant developments. The Board is interested in stakeholder views on CBDC and the issues that it raises, including: whether there would be demand for such an instrument given the electronic payment services already available to households; the extent to which it might contribute to a more resilient or competitive payment system; possible effects on financial stability and financial intermediation; and the implications for the current review.
• whether there are any policy issues particularly relevant to this review that arise from the prospective issuance of ‘global stablecoins’. The Bank notes that Bank staff are engaging closely with other Australian regulators and agencies on this topic, and are also participating in international groups that are examining potential regulatory and policy issues.

3.2 Competition in the Cards Market

3.2.1 Dual-network debit cards and least-cost routing

As Australians have shifted away from cash and cheques, card payments have grown rapidly. Most of the rapid growth in card payments has occurred in debit cards (Graph 6), and the debit card has emerged as the most frequently used payment method in Australia. Over recent years, the Board has considered a number of issues relating to competition in the debit card market, most notably around dual-network debit cards (DNDCs).^[10]

Around 90 per cent of debit cards issued in Australia are DNDCs, which allow a domestic point-of-sale payment to be processed via either eftpos or one of the other debit schemes (Debit Mastercard or Visa Debit); to date, however, online or foreign transactions have only been feasible via an international scheme. A payment made using a DNDC typically draws on the same deposit account regardless of which debit card scheme processes the transaction. The three schemes also offer similar protections to the cardholder in relation to fraudulent and disputed transactions. However, from a merchant's perspective, the cost of accepting a debit card payment can vary depending on which of the three networks processes the transaction. For most merchants, payments via eftpos can be significantly cheaper for them to accept than payments via the international schemes (Graph 4 and Graph 7).^[11]

When a cardholder inserts their DNDC into a terminal to make a payment, they are asked to select the debit card scheme to process the transaction (for example, by pressing CHQ or SAV for eftpos and CR for Debit Mastercard or Visa Debit). By contrast, if the cardholder makes a contactless (‘tap-and-go’) payment, the default is for the transaction to be automatically routed to the network which has been programmed as the default network by the issuing financial institution. Until around 2016, contactless payments were only available through the two international networks, which completed their rollout of contactless cards around 2012, and those networks were the default. However, with ePAL having completed its rollout of contactless functionality, contactless payments can now also go through the eftpos network.^[12] This raises the possibility of least-cost routing (LCR), whereby merchants might choose to route contactless transactions via whichever of the two networks on the card costs them less to accept. This can help merchants reduce their payment costs, and also increases competitive pressure between the debit schemes, with greater incentives for them to lower their fees.^[13]

The Bank has supported the issuance of DNDCs because they are convenient for users and can contribute to competition and efficiency in the payments system. In particular, they enable competition between networks at the point of sale, facilitating both consumer and merchant choice. Merchants have also favoured the continued issuance of DNDCs because they can help hold down payment costs if they allow the possibility of steering consumers to use a less expensive network. Recently, given that eftpos is a significantly lower-cost network on average, many merchants have expressed interest in getting access to LCR, to reverse the increase in payment costs that occurred with the shift to contactless transactions and the international schemes. The issuance of DNDCs and the provision of LCR functionality have also been supported in reports by the BETF and the Productivity Commission, and in the Government's responses to those reports.

However, over the past decade, disputes have arisen regularly between schemes regarding DNDCs. For example, over 2010–13, disputes arose over a number of issues including: international scheme rules that required the provision of commercially sensitive data about one network to a competitor network; the imposition of fees by one network on another network's transactions; and the placement of network brands on cards. Fresh disputes arose in 2016 as ePAL was seeking to have some of its issuers begin provisioning and tokenising DNDCs in mobile wallets to enable mobile payments. More recently, there have been concerns about the potential for international schemes to discourage merchants from adopting LCR by increasing the interchange fees that apply to a merchant's credit card transactions if it implemented LCR for debit card transactions.

For financial institutions, there may not be strong incentives for the continued issuance of DNDCs and the provision of LCR. For card issuers, there may be incentives to negotiate exclusive single-network contracts with a scheme that offers higher average interchange fees and large upfront financial incentives. In addition, issuers may wish to avoid the extra costs associated with supporting a second network on a card, especially as new technologies lead to a rapid pace of change in card issuance. For example, some smaller issuers have recently indicated to the Bank that it is costly for them to maintain two networks on their debit cards and to carry out largely duplicative activities such as regular upgrades of cards to the standards of both schemes (for example, in chip compliance) and investment to enable both scheme networks in mobile wallets. Indeed, when issuers have introduced new functionality – such as enabling Apple Pay for cardholders – they have often done so first for an international scheme, with no firm plans for also enabling eftpos.

As payment costs rose with the strong growth in tap-and-go payments through the middle of this decade, merchant groups were actively calling on acquirers to provide LCR. However, the industry only began to consider providing LCR following pressure from the Bank and from the review of Australia's four major banks by the House of Representatives Standing Committee on Economics in 2017.^[14] While a few smaller acquirers began offering LCR in 2018, progress by the major banks and other acquirers was slower, with the four major banks launching their LCR functionality only between March and July 2019. There are some key differences in the LCR capabilities offered by different acquirers, with some not yet offering a version that maximises merchant savings by enabling routing based on transaction size and payment network. In addition, for some acquirers, LCR is not yet available on all the payment terminals they support. Perhaps most importantly, some of the major banks are currently only offering LCR for merchants – typically larger ones – which are on interchange-plus pricing contracts. None of the major banks has taken advantage of the ability to implement LCR ‘in the background’ as a way to offer improved pricing for smaller and medium-sized merchants on ‘simple merchant plans’.^[15]

As LCR functionality has been gradually rolled out, schemes have responded with lower interchange rates for merchants that might be considering adopting LCR (Graph 8). However, there are several factors which may be limiting the overall downward pressure on merchant payment costs. First, lower interchange rates for some debit card transactions have been accompanied by increases in rates on other types of cards and/or transactions, in some cases for segments of the market where LCR is not an option. Second, the Bank has continued to hear concerns that merchants may lose access to favourable strategic rates on credit transactions if they adopt LCR for debit transactions. Third, there appears to have been only limited competitive response in the form of lower scheme fees (discussed below), which also affect payment costs to merchants and where the international schemes appear to remain more expensive than eftpos.

The Bank has made a number of interventions over the past decade or so that serve as background for the two consultation questions at the end of this section:

• In August 2013, the Board accepted undertakings from the three debit networks that were intended to safeguard the rights of Australian issuers to maintain existing dual-network arrangements in the contactless environment.^[16] The three networks committed: to work constructively to allow issuers to include applications from two networks on the same card and chip; not to prevent merchants from exercising choice in the networks they accept, in both the contact and contactless environments; and not to prevent merchants from exercising their own transaction routing priorities when there are two contactless debit applications on one card.
• In 2016–17, the Bank undertook a public consultation in response to concerns about possible restrictions on the ability of card issuers and mobile wallet providers to enable both networks on DNDCs for use on a mobile device.^[17] Following discussion with industry, the Bank received commitments from the relevant parties that they would not take any steps that would prevent the use of both networks on DNDCs in mobile wallets. These commitments were shared with industry participants, with the expectation that they should facilitate greater choice and convenience in the payment options available to card holders through mobile devices and improve the ability of merchants to encourage the use of lower-cost payment methods.
• During 2017–18, the Board considered the case for mandating LCR, given the slow pace of industry progress in providing LCR functionality. In May 2018, with commitments made by the major acquirers, the Board determined that a standard was not required, but asked the staff to closely monitor developments. The Board has also stressed that the benefits to competition from LCR should not be prevented by issuers removing networks from DNDCs. In addition, given concerns from some merchants that the international card schemes might respond to a merchant's decision to implement LCR for debit card transactions by increasing the interchange fees that apply to that merchant's credit card transactions, the Bank sought assurances from the three schemes that they would not respond to LCR in ways that would limit competitive pressure in the debit card market. The Bank has been monitoring developments in this regard.

For this review, the Bank is interested in stakeholder views on some particular issues regarding DNDCs and LCR.

First, the Bank is interested in views on the availability and functioning of LCR to date. The Bank notes that LCR is bringing down payment costs for some types of merchants and transactions, but that payment costs for other merchants may have risen as schemes have increased some interchange fees. The Bank also notes that acquirers typically have not taken advantage of the potential cost savings from LCR to offer more competitive ‘simple merchant plans’ to their smaller merchants (e.g. offering a greater value of transactions for a fixed monthly payment, or a lower monthly payment for a fixed value of transactions). This raises the question of whether additional, possibly regulatory, actions might be warranted regarding LCR to enhance competition in the debit card market. Options could potentially include consideration of measures such as requiring that acquirers explicitly offer all merchants the option of LCR for DNDC transactions and that schemes publish explicit criteria for any preferred or strategic interchange fees and that any such criteria not be related to acceptance decisions relating to other payment systems.

Second, the Bank is interested in views on some broader issues regarding DNDCs. The DNDC, which enables the possibility of the merchant being able to choose the routing of a transaction, is an attractive payment instrument from a competition and efficiency perspective. Looking ahead, however, ‘cards’ seem increasingly likely to be electronic payment credentials that are pushed out electronically to digital devices such as phones and wearables, as opposed to pieces of plastic that are mailed out in the post. The functionality offered by a card will no longer be largely fixed for the several years between issuance of physical cards, but will be able to be changed regularly reflecting innovation by schemes, issuers, mobile phone operators and others. Policy interventions to encourage dual-network provisioning in this world will likely become more challenging and disputes such as have occurred over contactless payments, mobile provisioning and tokenisation are likely to be frequent.

If incentives offered by the international schemes to issuers were to lead to the issuance of single-network international scheme cards, LCR would no longer be feasible on these cards, and the decline in the market share of eftpos seen over the past decade would likely continue. With less prospect of LCR, it is likely that there would be an increase in payment costs to merchants. In such an environment where single-network debit cards were becoming the main type of card issued, the Bank would likely need to assess the impact on competition and efficiency in the debit card system.

One possible policy response to any upward pressure on payment costs would be a reconsideration of the level of the interchange benchmark for debit cards. An alternative could be to set separate interchange fee benchmarks for single-network cards and DNDCs. Issuers might be incentivised to issue DNDCs if the interchange cap for transactions on DNDCs with full functionality to enable LCR were higher than for single-network card transactions. Another possibility might be regulatory actions to facilitate the entry of new schemes that could compete more aggressively to be the low-cost scheme on DNDCs. This might include consideration of the effect of the current long-term exclusivity arrangements between issuers and international schemes, which may hinder the entrance of competitor schemes. Alternatively, to the extent that the slow roll-out of LCR reflects the lukewarm support for eftpos from its members, it may be worth considering whether the governance of ePAL needs to be strengthened.

Another policy option might be explicit regulatory action regarding the issuance of DNDCs. For example, the approach taken in the ‘Durbin amendment’ in the United States obliges all issuers with over US$10 billion in assets to have two unaffiliated networks on a debit card, to enable merchant choice of routing. Such an approach would support LCR, and could help maintain downward pressure on interchange and scheme fees. To be effective, however, it might have to be supported by regulation covering online and mobile payments (e.g. where card credentials are tokenised) that ensured that both networks remained accessible to merchants as the industry shifts away from physical cards to digital credentials. Consideration of regulation would also have to address the role of BINs in DNDC transactions.^[18] There would also have to be consideration of the current issuance of eftpos-only (‘proprietary’) cards, which the international schemes have objected to.^[19] The Bank notes that there appears to be limited evidence available as to how effective the Durbin amendment has been in facilitating LCR, especially as regards some of the challenges posed by mobile and remote payments, tokenisation, etc.

3.2.2 Competition in card acquiring

The reforms implemented by the Bank and the ACCC as part of the 2015–16 Review have served to improve the information available to merchants about their payment costs. Acquirers and payment facilitators are now required to provide merchants with monthly and annual statements that clearly set out their average cost of acceptance for each of the card payment systems regulated by the Bank. This greater transparency of payment costs should make it easier for merchants to seek quotes from other providers and to negotiate with their existing acquirers. Greater competition in the acquiring market should exert downward pressure on payment costs, and consequently the prices paid by households for goods and services.

While market forces are likely to result in competition for the payment flows of large merchants, the Board has on a number of occasions noted its concerns about whether the needs of smaller merchants are being sufficiently met by acquirers. This concern has been reinforced by the recent experience with LCR. For example, as discussed above, the Bank is not aware of any evidence that any of the major banks have yet taken advantage of LCR to offer lower-cost payment plans to smaller merchants.

Data collected by the Bank provide confirmation that smaller merchants tend to pay significantly higher merchant service fees than larger merchants (Graph 9). In 2018/19, the average cost of acceptance for four-party scheme cards was around 1.5 per cent for merchants with annual card transactions of less than $100,000 (over 40 per cent of all merchants), and 0.9 per cent for merchants with annual transactions of between $100,000 and $1 million. In contrast, merchants with annual card transactions of more than $10 million faced average acceptance costs of less than 0.6 per cent.

Interchange fees may account for part of the differences in merchant service fees. Larger merchants are more likely to benefit from favourable strategic rates or particular industry rates. However, the effect of interchange rates on average merchant service fees is likely to be smaller than it was prior to the regulatory changes in the 2015–16 Review, which had the effect of significantly lowering the gaps between the strategic rates offered to large merchants and the high interchange rates on premium and corporate cards that fell disproportionately on smaller merchants.

Rather, the higher cost of acquiring services for small firms is likely to be more a reflection of the costs and margins charged by acquirers than of the interchange (or scheme fee) component set by card schemes. To some extent, this may be justified by economies of scale and the fact that the fixed costs of providing services to a small merchant will be spread over a smaller volume of transactions. However, the pricing of simple merchant plans offered by the major banks suggests that some other factors may also be involved. The marginal cost of additional transactions in these plans is typically around 1.5 per cent, well above the likely marginal cost of interchange and scheme fees, and implying a margin much larger than that typically paid by merchants on interchange-plus contracts. The Bank will be gathering further information around fee and margin arrangements as part of this review.

This suggests there may be some impediments to competition in the acquiring market for smaller merchants. One of these impediments may be the relatively higher barriers to switching faced by smaller merchants. The costs of searching for and switching to an alternative payment facilitator, for example, are more likely to outweigh the benefits for a merchant with low transaction volumes. This would be compounded if acquiring services for small merchants are bundled into broader business banking packages. Smaller merchants may be less familiar with some of the technical aspects of payments, and have fewer resources available to help understand the complexities of interchange fees, scheme fees and the like. More broadly, smaller merchants may have less negotiating power in relationships with their acquirers, and may be less likely to choose, or be offered, plans that would minimise their payment costs.

Impediments to competition in the acquiring market may also arise if there are barriers to entry or expansion. Since the modification of the access regimes for the international schemes in January 2015, a number of new acquirers have become participants in the card schemes. However, the acquiring market continues to be dominated by a small number of large institutions, with the four major banks acquiring more than 90 per cent of the value of four-party card transactions. New entrants offering innovative technology could also face barriers to entry, for example if there were problems in the process for certifying ‘non-standard’ card acceptance products for use in the Australian market.^[20]

The Bank is interested in stakeholder views regarding the degree of competition in the acquiring market and any possible policy action that could address shortcomings in competition. This may include consideration of policies that: reduce barriers to entry and innovation in the acquiring market; further enhance the transparency of merchant payment costs (for example breaking down total fees into the components attributable to interchange fees, scheme fees and acquirer margins); and otherwise facilitate merchants' ability to compare and switch acquirers. Similar issues are currently being considered by the UK PSR in its review of card acquiring services.

3.2.3 Scheme fees

Scheme fees are per-transaction fees payable by both acquirers and issuers to card schemes for services that they provide. Scheme fees, like interchange fees, directly affect costs faced by merchants in accepting card payments. However, while schemes publish their schedules of interchange fees, there is far less transparency around scheme fees. The Bank understands that the international schemes have schedules of hundreds, if not thousands, of individual fees but these are not published. The fee schedules are usually a combination of global and domestic fees. Listed fee schedules may be subject to bank-specific rebates or discounts to encourage card issuance and exclusivity arrangements.

The Bank has previously considered issues relating to greater transparency of scheme fees. The 2007-08 Review raised the prospect that the level of scheme fees be made available to all merchants as a means of increasing competitive tension in merchant service fee pricing. In particular, merchants that wished to would be able to back out acquirer margins using scheme and interchange fees, and rely on this information to negotiate for lower merchant costs from their acquirers. Following that Review, the Bank considered some possible mechanisms for scheme fee transparency, but did not proceed with specific regulatory action.

It may be timely to revisit the issue of scheme fee transparency as part of this review. With the declining use of cash and cheques, card payments represent an increasing share of household payments. In addition, information from some stakeholders suggests that scheme fees on acquirers and issuers have been growing over time and represent an increasing proportion of merchant service fees. Accordingly, the Bank invites stakeholder views as to whether it would be in the public interest to have greater transparency over scheme fees. There could be a number of potential benefits to greater transparency including:

• greater transparency to merchants on this significant component of payment costs, which may enable more informed negotiations with acquirers and more informed decisions on transaction routing
• greater transparency to the Bank regarding possible circumvention of interchange regulation through payments to issuers
• information that may be relevant to understanding the degree of competition in electronic payments.

3.2.4 Access regimes

In 2015, the Bank varied the access regimes initially imposed in 2004 on the Mastercard and Visa credit card schemes. These variations provided greater flexibility for the card schemes to broaden membership beyond existing participants. The variations required the schemes to publish transparent eligibility and assessment criteria, the maximum time they will take to assess an application, and also obliged the schemes to report information about membership approvals and applications to the Bank.

The revised access regimes appear to be working effectively. Both schemes have admitted new participants in each year since the 2015 variations came into effect, and have met their publication and reporting requirements. Where processing of applications has in some cases been outside of the timeframes published on schemes' websites, this has been attributed to applicants sometimes taking additional time to provide information in relation to scheme assessment criteria. The Bank has received very few complaints from would-be participants regarding delays in access applications, but would be interested in hearing the views of stakeholders.

3.2.5 Digital wallets and mobile payment applications

In recent years, technology firms including Apple, Google and Samsung have launched digital wallets for use in their respective mobile platforms. These digital wallets store electronic representations of payment cards, tokenised to protect the card number, that can be used to make contactless payments at the point-of-sale using the communication capabilities of the mobile device. Payments are processed using the card scheme network the payment card was issued under. While not all card issuers in the Australian market currently support each digital wallet, many card issuers, including some smaller banks, credit unions and building societies support one or more digital wallets.

Mobile platforms and handset manufacturers may have rules relating to access to different aspects of the functionality in their devices. Google's Android has supported third-party use of NFC functionality, including for payment applications, since 2013. By contrast, until recently (for example, to allow NFC capability for scanning ePassport data), Apple prevented third-party use of NFC functionality in the iPhone, and it still does not provide access for third parties to create their own payment applications that directly use NFC functionality. In July 2016, this was the subject of an application to the ACCC by three of the major banks and one other bank. In particular, the four banks sought authorisation to negotiate collectively with Apple regarding access to the iPhone's embedded NFC controller and the Apple App Store, in order to provide their own digital wallets with embedded access to the NFC without relying on Apple Pay. In March 2017, the ACCC denied the application on the basis that the likely benefits from providing banks with access to the iPhone's NFC functionality did not outweigh the likely detriments.^[21] At the time of the ACCC decision, only one of the four major banks and a number of smaller institutions using an aggregator had enabled their cardholders to use Apple Pay; currently more than 80 financial institutions, including three of the four major banks, have enabled Apple Pay.

Given the growing importance of mobile devices and digital wallets in card transactions, the Bank would be interested in receiving information from stakeholders on the additional functionality and benefits provided, as well as the costs involved. The Bank would also be interested in stakeholder views on any issues related to access to such platforms. In particular, this could include views on whether new entrants have appropriate access to digital wallets and if a broadening in third-party access to NFC functionality (with appropriate security) could have benefits for competition and efficiency in the market for digital wallets (this issue is reportedly also being given some consideration in Europe – see ‘Box B: Retail Payments Reforms in Other Jurisdictions’).

Another type of digital wallet technology that has emerged in other jurisdictions, but has to date not gained widespread use in Australia, is QR-code based payment technology. The most prominent cases are Alipay and WeChat Pay, the Chinese mobile payment applications that have gained a large share of the payments market in China. These companies have been able to fill gaps in the Chinese market, capitalising on their large user networks – in online, retail and social messaging channels – and making use of QR code technology to make payments more convenient. In China, QR codes have provided a cost-effective way for merchants to accept electronic payments in an environment where many of them were previously unable to do so, largely because of a lack of access to card payment terminals.

NPP Australia, the operator of the NPP, Australia's fast retail payments system, has recently published a QR code standard for use of QR codes on the NPP. This standard is based on the global EMVCo QR code specification and, while not mandatory, is aimed at standardising NPP QR code payments and promoting interoperability. Additionally, the payments industry association AusPayNet is currently considering incorporating the EMVCo QR code specification (or aspects of it) into the industry rules that govern participation in various clearing streams in Australia, such as cards and the bulk electronic clearing system. AusPayNet is also investigating industry appetite to create a single QR code interface, similar to the Singapore QR Code developed by the Monetary Authority of Singapore.

While these types of mobile payment applications are not widely used in Australia, the Bank understands that there are now a number of merchants accepting QR-code based payments. The Bank would be interested in receiving information from stakeholders about the current extent of their use, any future proposed adoption of QR-code based payments, and any potential policy issues they raise.

3.3 Interchange and Net Compensation Regulation

3.3.1 Interchange fees

Two recent Government-commissioned reports have made recommendations in relation to interchange fees. The final report of the BETF recommended that the Bank should consider whether there are further actions that it could take to put downward pressure on interchange fees.^[22] The BETF considered that there was little justification for the imposition of significant interchange fees in mature card systems, and suggested that the Bank consider overseas experience, in particular the EU reforms that set hard interchange caps for both debit and credit card consumer transactions. More recently, in its 2018 Inquiry into Competition in the Australian Financial System, the Productivity Commission recommended that the Bank should completely ban interchange fees (see ‘Box C: 2018 Productivity Commission Recommendations’).^[23]

One possible consequence of further lowering the interchange fee benchmarks would be that it could provide a competitive advantage to three-party schemes, which are not subject to interchange fee regulation and may therefore have more scope to offer rewards to cardholders to incentivise take-up and use of their cards, funded by higher merchant fees. If this were the case, then it is possible that any near-term lowering of payment costs from a reduction in the weighted-average benchmark for credit card transactions could be offset in the longer-term by a shift towards more expensive three-party cards. However, the Bank notes that the indirect effects on three-party merchant service fees of earlier regulatory changes involving interchange fees and surcharging appear to have been at least as large as the more direct effects on merchant service fees on four-party credit transactions (Graph 4). This suggests that there have been competitive constraints on the ability of three-party schemes to expand their market share at the expense of the four-party schemes that are subject to interchange regulation. Moreover, to the extent three-party schemes were able to obtain a competitive advantage from a further lowering of the credit card interchange benchmark, there may be regulatory responses the Bank could consider to improve the efficiency of the payments system. One option, as suggested by the Productivity Commission, would be for the Bank to regulate merchant service fees charged by the three-party schemes. The Bank would be interested in stakeholder views on the effects a further reduction in interchange fees on credit cards might have on competition between three- and four-party schemes, and what regulatory options might be considered to address this.

In addition to the issues outlined above, stakeholders may also wish to comment on other issues relating to interchange fees, including the following:

• The effects of the changes to interchange regulation stemming from the 2015–16 Review. The most noteworthy changes include the reduction in the weighted-average debit benchmark from 12 cents to 8 cents per transaction, and the imposition of caps on individual interchange fees (80 basis points for credit and 15 cents or 20 basis points for debit).
• Developments in debit interchange strategies in response to LCR, in particular in relation to the strategies of the international schemes, which have traditionally set their schedules to keep weighted-average interchange fees close to the benchmark; by contrast, average interchange fees in the eftpos system have (since 2012) always been well below the benchmark. For the international schemes, recent reductions in interchange fees for some categories have typically been accompanied by increases in other categories, implying increases in payment costs for some merchants.
• Implications of the ongoing fall in the average value of card transactions, especially for debit. The average transaction value for debit cards is now around $48, down from $69 in 2009 and $56 at the time that the Board took the decision to lower the weighted-average benchmark for debit and prepaid from 12 cents to 8 cents. For some low-value debit transactions that are subject to cents-based interchange fees, the interchange fee payable on a debit transaction may be significantly higher than if a credit card had been used.
• The issuance of premium international scheme debit cards, which represent a small but growing share of transaction volumes. These cards may provide benefits such as cashback or fee-free foreign transactions. They are more expensive for merchants given that interchange fees for these cards are set at the maximum level permitted by the standard. Where these cards provide certain additional benefits to cardholders when used in one network rather than another, cardholders may not be indifferent as to the routing of their transactions; stakeholders are invited to comment whether it should be for merchants to disclose the use of LCR or for issuers of these cards to advise their cardholders to make proactive choices regarding network selection.
• Issues regarding compliance with the weighted-average benchmarks. Following the 2015–16 Review, the compliance cycle is now quarterly, as opposed to three-yearly (or whenever schemes undertook a voluntary reset). When the Bank was consulting on this change in 2016, the international schemes argued that frequent resets of their interchange schedules were costly for the industry to implement. While the international schemes have the option of setting interchange fee schedules conservatively to avoid exceeding the benchmark and limit the frequency of mandatory resets, they have not done so; resets for credit card interchange fees have been required at almost every compliance date. The Bank is interested in views from merchants, acquirers and issuers as to the cost of these frequent resets of interchange fee schedules and on any alternative approaches that might involve lower costs but would be effective in keeping interchange rates from drifting above the benchmarks.
• On a technical matter, reversals, credits, and chargebacks are currently excluded from the definition of transactions for the purposes of the interchange standards. An alternative approach would be to define transactions as net of reversals, credits and chargebacks. At the margin, this would slightly lower the overall level of interchange fees permissible under the Bank's standards. The Bank notes that there is now a wider range of transaction types that are processed as credits or reversals and would be interested in views of stakeholders as to the costs and benefits of alternative approaches to the definition of transactions.

Finally, the Bank is interested in views on whether interchange regulation should be extended to foreign-issued cards used to make payments in Australia. Interchange fees on transactions on foreign-issued cards are significantly higher than those on domestic cards. There are currently no restrictions on the interchange fees levied on these transactions, and schemes are not required to publish inter-regional interchange fee schedules. Payments made using foreign-issued cards at Australian merchants as a share of card payments – both in person and online – have increased over the past decade. In the 2015–16 Review, the Board decided not to bring transactions on foreign-issued cards into the regulatory framework, but indicated that it would continue to watch developments in this area. As noted earlier, in 2019, the EU accepted legally binding commitments from Mastercard and Visa to reduce their inter-regional interchange fees to or below caps set by the EC,^[24] to refrain from circumventing the caps, and to publish inter-regional interchange fees. It is estimated that the voluntary commitments by the schemes would reduce interchange fees on foreign-issued cards used in the EEA by 40 per cent on average.

3.3.2 Net compensation

In 2018–19, the Bank conducted a limited-scope review of the interchange standards, focusing on clarifying and improving the operation of the net compensation provisions. The resulting variations that came into effect on 1 July appear to be broadly operating as intended, and the Bank is not proposing to revisit these issues in detail in this review. However, the Bank would welcome stakeholder views on other issues related to compliance with the net compensation provision.

The interchange standards prohibit issuers from receiving net compensation from a scheme, but do not prohibit schemes from paying net compensation to its issuers. Thus, the substantive obligation to comply with the net compensation provision rests with issuers. While the schemes have not objected to providing certifications of their compliance with the net compensation provision to date, the absence of a substantive obligation on schemes may limit the enforcement options in relation to any breaches of the provision. This raises the possibility of schemes offering large incentives to potential issuers to enter into an issuing agreement without consequence to the scheme should these incentives amount to net compensation. The Bank is therefore interested in stakeholder views on whether a substantive obligation regarding net compensation should also be imposed on schemes.

The Bank is also interested in stakeholder views regarding what actions the Bank should take, or should have the power to take, following any breach of the net compensation provision (under current legislation or through a change to legislation). Issuers and schemes report on their net compensation position soon after the end of each financial year. In the event of a breach, options might include:

• for marginal breaches, no action if this was justified on materiality grounds
• issuance of a direction requiring a true-up/true-down of the excess compensation (effectively, a repayment of the amount by the issuer to the scheme or downward adjustment to an accrued entitlement of the issuer)
• issuance of a direction that has the effect of lowering the net compensation threshold in the following year by the amount of the breach
• a reduction in the interchange benchmark for a future period (say, by expressing the amount of the previous year's breach as a percentage of relevant transaction values and reducing the benchmark by some multiple of the resulting number of basis points) – the reduction in the benchmark could potentially be applied just to the relevant issuer or to a scheme broadly (i.e. across all issuers in that scheme)
• acceptance of a voluntary undertaking from an issuer to take actions addressing the breach
• sanctions as discussed in section 3.5.

A relevant consideration in relation to some of these options is whether they may effectively reward a scheme for a breach. This might be the case with a requirement to ‘undo’ the breach by repayment or adjustment to an accrued entitlement or lowering the effective net compensation threshold.

3.4 Surcharging

The revised surcharging framework put in place following the 2015–16 Review preserved the right of merchants to surcharge for more expensive payment methods but required surcharges in designated card systems to be more closely linked to the cost of acceptance.^[25] It was also accompanied by changes to the Competition and Consumer Act 2010 that provided the ACCC with investigation and enforcement powers to take action in cases where merchants might be surcharging excessively.^[26]

As a result of these changes, there have been a few significant enforcement actions taken by the ACCC. In addition, the revised framework has required reductions in surcharges by some prominent large merchants where there had previously been concerns about surcharging practices. For example, the two large domestic airlines had previously imposed fixed-dollar surcharges on domestic airfares. While these amounts may not have been excessive in terms of the overall amount of revenue raised, they were clearly above the airlines' cost of acceptance for lower-value fares. Following the 2015–16 Review, the airlines changed their surcharges to be percentage-based. Furthermore, as the cost of card acceptance has fallen for the airlines, no doubt partly reflecting the changes to interchange regulation in the 2015–16 Review, the airlines have further reduced their surcharges. For example, in September 2016 Qantas replaced its fixed-dollar surcharges of $7 for credit cards and $2.50 for debit cards with a 1.3 per cent surcharge for credit/charge cards and a 0.6 per cent surcharge for debit/prepaid cards, with caps of $11 for domestic and trans-Tasman flights and $70 for international flights. Since then, it has reduced these percentage rates to 1.03 per cent for credit cards and 0.36 per cent for debit cards. The result has been a very significant reduction in the surcharges applying to lower-value air fares.

While the Bank's preliminary assessment is that the revised surcharging framework has been functioning well, the Bank invites stakeholders' views, including on any possible modifications. In addition, the Bank is interested in stakeholder views on two specific issues.

First, the Bank is aware of a few merchants that are applying differential surcharges for cards within a system, though this is not explicitly contemplated in the surcharging standard. In particular, they are applying different surcharges to domestic- and foreign-issued four-party credit cards, in line with the (significantly different) acceptance costs of the two types of cards. The Bank's view is that this is consistent with the intent of the standard, providing that the surcharge rates are each set no higher than the respective costs of acceptance. In addition, the Bank is aware of merchants that are interested in surcharging standard and premium four-party credit cards differently. The Bank is interested in stakeholder views as to whether it would be desirable to explicitly provide for the possibility of such differential surcharging, subject to no excessive surcharging for any type of transactions.

Second, the Bank would be interested in stakeholders providing information regarding the observance of the requirement in Clause 6.3 of the surcharging standard, relating to the provision of BIN lists by schemes or acquirers allowing for the electronic identification of different card types. In particular, as payment cards are tokenised for digital payments, the Bank considers it is important that merchants continue to have access to information on tokenised BINs so they will have the ability to identify whether a card is a credit, debit or prepaid card. Without such lists of BINs, merchants that choose to surcharge could be at risk of ACCC enforcement action due to inaccurate information about the card type.

The Bank is also interested in stakeholder views regarding the growth in the use of buy-now, pay-later (BNPL) services. These are services in which customers are able to purchase goods or services but defer payment via low- or zero-interest instalments to the BNPL provider, typically over 1–2 months. While arrangements vary, some of the prominent BNPL providers have models whereby the service is ‘free’ for consumers if payments are made on time, with merchants charged a relatively high per-transaction fee for accepting the payment. Customers typically make instalment payments to the BNPL provider using a debit or credit card.

These services have become widely accepted by merchants in a number of retail segments, both online and in person. Data from several large BNPL providers indicates that the value of BNPL transactions has grown considerably in the past few years (Graph 10). The number of providers and products in the BNPL sector has also expanded during this period.

From a consumer perspective, the popularity of BNPL services may relate to their convenience and availability as a potentially lower-cost form of consumer credit. There are indications that BNPL services are used more intensively by certain segments of the population, particularly younger people, who may not have a credit card. For merchants, it has been argued that BNPL services may facilitate increased sales as well as provide additional benefits – for example, as merchants are paid upfront by the BNPL provider, they do not bear the risk of fraud or customer non-payment.

Stakeholders such as smaller businesses have observed that the cost of accepting BNPL payments – in terms of the fees paid by the merchant to the provider – is often in the range of 3–6 per cent and is generally higher than the cost of accepting other electronic payment methods such as cards. Most BNPL providers also have rules that prevent merchants from levying a surcharge on the customer to recover those fees.^[27] This may increase the overall cost of accepting payments for merchants that feel compelled to offer BNPL services as a payment option for competitive reasons, but are unable to recoup the merchant fees from the customers that directly benefit from the service.

The Bank has long been of the view that the right to apply a surcharge on more expensive payment methods plays an important role in signalling the costs of different ways of making payments to consumers. If a business chooses to apply a surcharge to recover the cost of accepting more expensive payment methods, it is able to encourage customers to consider making the payment using a cheaper option. The possibility that a consumer may choose to pay with a lower-cost option when presented with a surcharge also helps put competitive pressure on the pricing policies of payment providers, indirectly lowering merchants' payments costs. By helping keep merchants' costs down, the right to apply a surcharge means that businesses can offer a lower total price for goods and services to all of their customers.

The Bank is interested in stakeholder views on the no-surcharge rules of some BNPL providers. An issue for the Bank is that, unlike card schemes, BNPL providers typically have no-surcharge rules to prevent merchants from recovering the cost of acceptance from consumers via a surcharge.^[28] Accordingly, merchants that accept both cards and BNPL payments are permitted to apply a surcharge to recover the cost of accepting a traditional card payment but are unable to recoup the cost of accepting a more expensive BNPL payment funded by a provider that may receive its repayments through a debit or credit card. The Bank notes in this regard that it would take a negative view of any arrangements where a currently regulated card scheme used a BNPL structure to try to re-establish no-surcharge rules.

Stakeholders may wish to provide information on some of the following questions:

• How do merchants and other stakeholders view the benefits and services that BNPL models provide?
• How do the costs of payments received through BNPL services compare with the cost of traditional card payments?
• Has the recent entry of additional BNPL providers influenced merchant fees for BNPL services?
• Do all BNPL providers have binding no-surcharge rules or are merchants able to negotiate on these?
• Are some BNPL services viewed as ‘must take’ payment methods for particular market segments or transaction types; that is, do merchants feel that they cannot refuse to accept BNPL for fear of losing business?

3.5 Regulation and Enforcement

Compliance with the Bank's standards and access regimes is generally effectively observed by schemes and payments system participants (e.g. interchange schedule resets occur within the time required where a scheme is above an interchange benchmark). Industry participants are also usually willing to provide data and information to the Bank without it having to resort to use of its formal information gathering powers under section 26 of the PSRA. However, the net compensation provisions – which are more complex than some other aspects of the Bank's standards – have led the Bank to give some recent consideration to what powers it would have available in the event of a significant breach of a standard or access regime.

Where the Bank considers that a participant in a designated system has failed to comply with an access regime or standard, the Bank has a power under section 21 of the PSRA to give a direction to the participant to take or refrain from specified action as the Bank considers appropriate having regard to the failure to comply with the standard. Any direction must be consistent with any applicable regulation prescribed by the Bank (e.g. any other part of a relevant standard or access regime). The Bank may impose a timeframe by or within which a direction is to be complied with. If a participant fails to comply with, or otherwise contravenes the direction, then it commits an offence, and is subject to a penalty of 50 penalty units (currently equivalent to around $10,500) per day until the failure is remedied or the direction is revoked.^[29] The penalty for failing to comply with a direction is substantially lower than for offences under other legislation relating to the financial sector^[30] – and potentially means that the deterrence effect of the Bank's powers here is limited. This raises the question as to whether it might be desirable for the Bank to be given some additional regulatory powers or mechanisms:

• For example, whether the Bank should be able to establish and enforce penalties or remedial actions under, or for failure to comply with, a standard or access regime, rather than relying solely on a directions power and sanctions for failure to comply with a direction.
• Whether the size of potential fines under the PSRA should be increased.
• Whether other mechanisms should be available to the Bank to provide a broader range of effective regulatory tools, e.g. the ability to accept court-enforceable undertakings from payment system participants, including system administrators.

3.5.1 American Express Companion Card designation

The American Express Companion Card system was designated in October 2015, and Standards No.1 and No.3 of 2016 apply to it. As a result of the net compensation provisions, the four major banks have elected to cease offering companion cards. The Bank expects to revoke this designation in light of the cessation of these arrangements.

Endnotes

The industry association Australian Payments Network (AusPayNet) is currently undertaking an industry consultation on the future state of Australian payments; the outcomes of that consultation may be relevant to the broader landscape issues raised in this paper. [8]

See Wakefield and Finlay (2019). [9]

The Bank is also aware of an issue involving DNDCs, in particular involving purchases at Australian retailers using Chinese-issued cards which enable transactions to be processed by either the UnionPay network or by Visa or Mastercard. Some Australian merchants have suggested that the use of the UnionPay network would result in lower costs for both the Australian merchant and the foreign cardholder but that they have not been provided with the capability to process transactions in this way. [10]

Graph 7 shows the average costs of acceptance for a sample of almost 672,000 merchant accounts, divided into deciles based on the value of annual card transactions. Each decile contains 10 per cent of total transaction values. The size of some merchants in the sample may be understated since individual locations within chains or franchises may receive separate statements. The absence of observations for eftpos for the tenth decile suggests that all of the 31 merchant accounts in this group are billers or online-only merchants (with a single merchant account). [11]

The domestic eftpos payment scheme (or network) is governed by eftpos Australia Payments Limited (ePAL). [12]

LCR functionality can be made available to merchants by acquirers incorporating it in their terminals, often through a remote software update. Regardless of whether a merchant uses LCR, cardholders would still have the option to select a particular debit network by inserting their card in the terminal and making a selection rather than tapping. [13]

See House of Representatives Standing Committee on Economics (2017) and Reserve Bank of Australia (2017). [14]

A typical simple merchant plan has a fixed monthly fee which covers a certain value of transactions (for example, around $30 for up to around $1,500 of transactions, or $60 for up to $3,000) within a month, with the merchant then paying a fixed percentage fee (often around 1.5 per cent) for any additional transactions. Such plans typically do not differentiate between debit or credit card transactions or between transactions of different schemes. That is, a merchant will be paying the same percentage rate for transactions that may have very different costs (in terms of interchange and scheme fees) to the acquirer. [15]

See Reserve Bank of Australia (2013). [16]

See Reserve Bank of Australia (2016b). [17]

The BIN or Bank Identification Number (sometimes also referred to as an Issuer Identification Number or IIN) on a DNDC is the initial 6 digits of the (typically) 16-digit card number or Primary Account Number (PAN). Allocation of BINs and keeping a register of this allocation is done by the American Bankers Association. The BIN can be used to identify the financial institution issuing the card and the scheme it is issued under. To date, DNDCs have carried a single BIN and PAN that has enabled transactions via two schemes; the international schemes have, however, sometimes asserted rights over DNDCs where the BIN has been allocated to them. Looking forward, it may be feasible for DNDCs to have dual PANs, which might reduce the scope for disputes between schemes; indeed, it is noteworthy that when DNDCs are tokenised by different schemes, two tokens are created. However, requiring the industry to move to dual BIN and PAN arrangements would likely require additional investment by issuers and acquirers, including potentially modifying the way in which LCR is undertaken. [18]

The international schemes argue that the continued issuance of eftpos-only cards, which do not facilitate LCR, represents an undue advantage for ePAL. It would of course be possible for there to be issuance of cards with eftpos as first-priority network and an international scheme as the second-priority network for domestic use. The Bank would be interested in information as to whether there are any international scheme rules or policies that would prevent or discourage this option. [19]

AusPayNet has engaged with industry via its Issuers and Acquirers Community, aiming to provide a more effective process for adoption of card acceptance solutions that use different technology. See Australian Payments Network (2019). [20]

See Bendigo and Adelaide Bank & Ors (2016). [21]

See Recommendation 3.3, Black Economy Taskforce (2017). [22]

See Recommendation 17.1, Productivity Commission (2018). [23]

The caps set for card-present transactions are the same as those for intra-regional transactions, while the schemes were afforded a higher cap for card-not-present transactions. [24]

Following discussions with the Bank, several payment schemes that are not formally captured by the Bank's surcharging standard – American Express, Diners Club, UnionPay and PayPal – agreed to modify their surcharging rules in a manner consistent with the standard. [25]

See Dark et al (2018). [26]

An example of a merchant that does apply a surcharge on BNPL payments is Jetstar, which applies a payment surcharge of 1.5 per cent on Afterpay transactions. Similarly, Tigerair applies a fee of 1.25 per cent of transaction value plus 15 cents for customers using Zip Pay. [27]

The issue of surcharges for BNPL transactions was briefly referenced in Australian Securities and Investments Commission (2018): ‘Given existing surcharges for some credit card transactions, merchants may in the future seek to introduce surcharges for buy now pay later arrangements. The implications of this would need to be considered.’ ASIC noted that the BNPL providers focused on in its report are not regulated under the National Consumer Credit Protection Act 2009, as they either do not charge consumers for providing the credit, or they only include charges for credit that amount to an upfront fee or a periodic fee that is fixed and is less than specified amounts. [28]

For bodies corporate, a court may impose a fine of up to five times this amount (i.e. up to $52,500). [29]

For example, contraventions of Part IV of the Competition and Consumer Act 2010, which deals with anti-competitive practices, can lead to a penalty for a corporation that is the greater of: $10 million; three times the value that is ‘reasonably attributable’ to the benefit obtained as a result of the breach; or 10 per cent of the corporation's annual turnover in the 12 months preceding the breach. [30]