Introduction
Good morning everyone and thank you for your kind invitation. I am delighted to be here today, and I look forward answering any questions and participating in the panel discussion at the end of my presentation.
Today I will be speaking about the recent enforcement action undertaken by the Commerce Commission against Visa, MasterCard and the major New Zealand banks in respect of the credit card service fees that were being charged to merchants, and the market-based solution which we achieved through our settlement with these parties.
Competition authorities, central banks and other authorities around the world have been investigating and expressing concerns about the operation of card payment systems for many years. Reform has taken place in a number of jurisdictions, including here in Australia in 2003. In Europe, changes to the multilateral interchange fee (or MIF) has occurred in a number of countries, including Spain and Switzerland as well as for cross-border interchange fees for both Visa and MasterCard. A number of other EU countries, such as the UK and Italy, are in the process of reviewing card payment systems and how interchange fees are set. In the United States, the scheme arrangements have also been the subject of public and private litigation.
While most actions abroad have resulted in regulatory or quasi-regulatory intervention, the Commission has achieved a unique settlement through the litigation process, which should, over time, significantly change the competitive landscape of credit cards in New Zealand.
New Zealand context
Before I go into too much detail about the litigation and settlement, it is probably best for me to briefly describe the factual background of the New Zealand credit card market, as there are some features that make our market unique.
New Zealand consumers are among the world's most frequent users of payment cards to make purchases. While the number of cardholders, banks and merchants in New Zealand is relatively small compared to some countries, the penetration of payment cards among merchants and consumers is extremely high. Per capita, we have some of the highest debit and credit card usage of any country. There are some 2.7 million credit cards in the market and around 5 million debit cards for a population of 4.2 million people. Not surprisingly, we also have the highest penetration of point of sale terminals per capita in the world.
Approximately 70% of all retail purchases are conducted using credit or debit cards. Non-cash payments are dominated by debit cards, commonly referred to as EFTPOS cards, which are ubiquitous and the majority of these transactions do not incur an interchange fee.
In respect of credit cards, it is estimated that around $1 out of every $5 of personal consumer expenditure is paid for by a Visa or MasterCard credit card, with Visa being the dominant brand. These two schemes constitute approximately 90 to 95% of credit card billings in New Zealand with the remaining portion being made up mostly by two competing three party schemes, American Express and Diners Club.
Similar to Australia, there are only a small number of players in the acquiring and issuing markets in New Zealand. The four major Australian banks are also the major banks in New Zealand (via subsidiaries) and are the major issuing and acquiring participants in New Zealand card payments markets. Unlike Australia and particularly the US, however, we currently have no independent acquirers,.
I'm sure you are familiar with the operation of Visa and MasterCard's four-party payment systems - New Zealand merchants who accept Visa or MasterCard card transactions do so through a contractual relationship with a New Zealand bank, who in turn is a member of the Visa and or MasterCard schemes.
When a cardholder uses a Visa or MasterCard credit card in New Zealand to purchase an item, the acquirer pays the merchant the value of the purchased item. The acquirer is then reimbursed for the transaction amount by the issuer.
The acquirer pays the issuer an interchange fee for each transaction, which is deducted from the transaction amount that is reimbursed to the acquirer. Acquirers pass on this fee to merchants through the merchant service fee (MSF). The cardholder pays the issuer the value of the original purchase when the payment card account is settled, plus any applicable card fees and interest charges.
The issuing and acquiring banks also pay scheme fees to Visa and MasterCard, in respect of the services provided by the scheme to each issuer or acquirer. These are quite distinct from the interchange fees paid by acquirers to issuers. Visa and MasterCard do not receive any part of the interchange fees paid by acquirers. Rather, the interchange fee is paid by credit card acquirers to issuers, as the schemes and banks claim, to compensate the issuers for some of the disproportionate costs that they must bear in providing their services.
All transactions between acquiring and issuing banks (except "on-us transactions", which are transactions where the acquirer and issuer are the same bank) go through the Visa or MasterCard settlement and clearing systems.
Multilateral interchange fees are the largest underlying expense component of the merchant service fee charged to New Zealand merchants, comprising on average about 75 to 80% of the total MSF. The remaining 20 to 25% is retained by the acquiring bank as their operating margin. Conversely, the MIF represents a significant source of revenue for issuers, providing for approximately 25% of their total revenue, as compared to cardholder fees (22%) and interest on revolving credit (53%).
There is a lock-step relationship between MSFs charged to merchants and the underlying MIF charged by issuers. Simply put, changes to the MIF cause acquirers to change the MSF charged to merchants. Unlike here in Australia, interchange fees in New Zealand are not regulated and the level of these fees has, prior to the settlements, been set at the scheme level without any regulatory control.
Role and function of the Commission
The Commerce Commission is the independent regulatory and enforcement agency responsible for ensuring that competition can flourish within New Zealand. In recent years, we have made a conscious effort to deter anti-competitive conduct by focusing on activities that cause the greatest detrimental impact on competition and consumers, and taking flagship cases that establish precedent and send clear messages to the market. The proceeding launched against Visa, MasterCard and their participating banks is very much in keeping with this approach.
Competition is the basic underpinning of a market economy. The most obvious benefit of competition is the pressure it exerts to achieve competitive prices and raise quality. It encourages innovation and productivity by creating incentives to work smarter, enabling company performance to be measured against the performance of competitors. To deliver these benefits, competition needs to be facilitated through robust legal frameworks.
Our primary enforcement statute is the Commerce Act, which is a set of generic competition laws that regulate anti-competitive market behaviour or structure in any market. We also enforce a number of pieces of legislation specific to the telecommunications, dairy and electricity industries, and by doing so, we aim to promote dynamic and responsive markets, so that New Zealanders benefit from competitive prices, better quality and greater choice.
Among other things, the Commerce Act prohibits contracts or arrangements that could lead to a substantial lessening of competition. Relevantly, Part 2 of the Act is concerned with trade practices that harm competition in markets in New Zealand. Section 80 under Part 6 allows the Commission to initiate proceedings in the High Court for the payment of pecuniary penalties by persons or businesses who are found to have contravened one or more of the provisions in Part 2 of the Act.
The maximum penalty that can be imposed on a business is the greater of $10 million, three times the value of any commercial gain resulting from the contravention; or if the commercial gain cannot be readily ascertained, 10 percent of the turnover of the company, including all of its interconnected bodies corporate. The maximum pecuniary penalty for an individual is $500,000.
Part 5 of the Act also allows the Commission to authorise proposed anti-competitive practices that would lead to the substantial lessening of competition in a market. To this end, the authorisation process requires a balancing of impacts and efficiencies. The Commission must not make a determination granting an authorisation to enter into a contract unless it is satisfied that the entering into of the contract will in all the circumstances result, or be likely to result, in a benefit to the public which would outweigh any likely lessening in competition (section 61(6)).
In this case, the defendants had the opportunity to seek an authorisation - they could have applied collectively to the Commission (including, in the case of the Visa scheme, through Cards NZ), or any one of them could have applied. They chose not to do so, and therefore it was not open to them to seek to convert the subsequent proceeding into a Part 5 authorisation hearing. Importantly, defences relating to efficiency or welfare were no longer available to them.
The Commission's Case
In November 2006, the Commission commenced proceedings against the Visa and MasterCard credit card schemes and their participating banks in New Zealand. We claimed that the defendants had breached Part 2 of the Commerce Act by agreeing and implementing the Visa and MasterCard scheme rules in New Zealand. The proceedings related to conduct in the period from November 2003 onwards.
The Commission's case, in summary, was that there was an arrangement between competitors in the acquiring market, other banks and the schemes which:
a.provided for the maintaining or controlling of the price for acquiring services, by way of the merchant service fee, in breach of section 30 of the Commerce Act; and/or
b.substantially lessened competition in the acquiring market, in breach of section 27 of the Act.
We did not allege any collusion between Visa and MasterCard but argued that there was an arrangement in respect of each scheme set out in interdependent and interlocking agreements with the banks relating to the operation of that scheme. The specific provisions of these agreements that the Commission challenged were:
- the 'MIF rules' which provided for the centralised setting by the schemes of a multilateral interchange fee, which had to be paid by an acquirer to a card issuer;
- the 'no surcharge rules' which prohibited surcharging of card transactions by merchants, and thus prevented merchants from passing on the cost of accepting credit cards;
- the 'no discrimination rules', which were closely related to the no surcharge rules and prohibited certain other forms of discrimination between card payments and other payments, and between cards from different schemes or issuers. For example, the rules prevented merchants offering prices, special deals or other incentives to encourage use of a particular card or payment method;
- the Commission also challenged the 'honour all cards rules' which required merchants to honour all Visa and MasterCard cards and prohibited selective acceptance of cards from some issuers, or specific types of cards; and
- lastly, the Commission objected to the access rules which restricted who was permitted to act as an acquirer of Visa or MasterCard transactions.
According to the Commission's theory of the case, these provisions breached section 27 and 30 of the Commerce Act because:
- The MIF, which was charged by issuers to acquirers, was a cost to acquirers which established a 'floor price' for the MSF charged by acquirers to merchants, and thereby maintained or controlled the MSF.
We perceived that the MIF acted like a sales tax, significantly and arbitrarily raising prices; nor was the MIF based on technologically and competitively determined costs, but set through a centralised process; and
- Just as relevant, the MIF did not operate in isolation. Sitting along side it were the scheme rules that I've just described, which eliminated opportunities for merchants to create incentives for issuers to charge lower MIFs. The rules, which were vigorously enforced, shielded cardholders from the cost of their payment choice, as they prevented merchants from recovering their costs of accepting credit cards or steering cardholders to a preferred payment method.
For example, in July 2000, a supermarket in Wellington instituted a 1% surcharge to recover the MSF cost. Within a week the merchant was terminated by its acquirer and it could no longer accept Visa or MasterCard. Shortly afterwards, the supermarket dropped the surcharge and their acquiring agreement was reinstated.
Because a retailer or service provider was stopped from recovering the service fee from the cardholder, it had to average out the cost of that fee across their sales. This, in turn, increased the cost of every item or service sold by businesses which accepted Visa or MasterCard, and all customers of those businesses bore the average fee, regardless of whether they paid by credit card, cash, EFTPOS or another payment method. To this end, consumers paying by cash, cheque or EFTPOS were helping to subsidise the cost of accepting credit cards and saddled with a disproportionate cost, as interchange fees were used by the banks, in part, to fund reward and loyalty programmes for cardholders; and
The Commission also considered that the scheme rules breached the Commerce Act as they hindered entry by specialist acquirers or self-acquirers, which reduced the competition faced by the four banks that act as acquirers in New Zealand. For example, Visa and MasterCard required that:
- scheme participants could not offer acquiring services unless they issued a minimum volume of Visa or MasterCard credit cards; and
- participants had to be, or had to be owned by, a financial institution that accepted demand deposits.
We also observed that there was limited transparency of the components which made up the cost of the merchant service fee, as merchants were charged 'bundled' MSFs as between MasterCard and Visa transactions. Merchants were often charged a single blended average rate on all transactions, regardless of the network brand or issuer. Although 'Interchange Plus' pricing was present in New Zealand, it was rare and restricted to large merchants.
By way of relief, we sought declarations that the schemes and banks had breached the Act, orders deleting the challenged provisions from the contracts, injunctions restraining the defendants from giving effect to the provisions and pecuniary penalties. As an aside, we chose to focus our investigation and subsequent proceeding on the significant market players, Visa and MasterCard, and reserve our position in respect of three party schemes and scheme branded debit cards, which we continue to monitor.
Our ultimate purpose in commencing this proceeding was to drive down the costs of the merchant service fees, which we perceived were set through a collusive arrangement and insulated from competition.
On the back of our proceeding, some of New Zealand's largest retailers brought a similar action against the schemes and banks also alleging that they had engaged in conduct which substantially lessened competition and controlled prices in the credit card acquiring market.
The Schemes and Banks' case
During the proceeding, we were met with a range of arguments about the necessity of the scheme rules and importance of the scheme setting the interchange fee. The banks and schemes argued that, among other things, changes to the scheme rules and the MIF would stifle innovation in the credit card market and, at the most extreme, lead to a death spiral of credit cards, as the rules formed an integral part of the structure of the market.
At their very least, however, the 2003 RBA reforms demonstrated to us that reductions to the MIF would not result in the collapse of the credit cards market. In fact, we saw evidence that cardholders in Australia have continued to use their cards and we understand that there have been significant increases in cards issued, transactions and spend since the reforms were introduced..
The rationale for interchange fees put forward by the card schemes was a combination of economic argument regarding two-sided markets and a cost based philosophy. Both schemes saw interchange as a 'delicate balancing mechanism' and indispensable to the operation of credit card systems. To make themselves a viable competitive alternative at the point of sale, the schemes argued that they needed to present an attractive value proposition to both issuers, so that they would choose to provide credit cards to consumers and encourage cardholders to pay with them, and to acquirers, so that they could negotiate with and sign retailers to accept credit cards. The level of the interchange, therefore, was designed to balance the push and pull of this two-sided market, and any changes to the interchange fee would disrupt the fragile equilibrium. Naturally, by virtue of their position as proprietors of the schemes, Visa and MasterCard saw themselves to be in the best position to determine what the rules and level of interchange should be.
The defendants also argued that the interchange fee was not an unjust burden on retailers but set to optimise participation in a scheme's network, which ultimately encouraged the widespread issuance and acceptance of credit cards, maximising the value of the brand for the benefit of its issuers, acquirers, merchants and cardholders.
In respect of the scheme rules, the defendants argued that the rules were justified as they had the following key functions:
- they protected the integrity and value of the brand and provide commercial certainty for its participants;
- they provided an appropriately high level brand experience for cardholders by, among other things, requiring the price at checkout to match the advertised price; and
- they prevented some merchants from using their position to charge supra-competitive prices to cardholders.
The schemes also challenged the market definition we adopted in pleading a breach of section 27 of the Act. They argued that the acquiring market was merely a 'derivative' sub-market, rather than a real market, and that any analysis had to consider the payments systems market as a whole - the issuing and acquiring markets could not be treated in isolation.
The defendants also argued that because the schemes unilaterally set the MIF, the conduct should be analysed as unilateral conduct, not as collective price-fixing and section 30 could not apply. A joint venture exception to the price fixing prohibition in section 30, under section 31 of the Commerce Act, was also raised which advanced the idea that, in setting the interchange fee, the parties had formed a joint venture to carry on the activity of providing acquiring services.
Many of the arguments advanced by the defendants and their experts were along the lines that the challenged rules were efficient and welfare enhancing, so section 30 should not apply to them. These arguments tend to take as their starting point US law and US writing on the scope of competition law prohibitions. However, none of these arguments are germane to the analysis required under the New Zealand Commerce Act. Also, the SLC analysis in section 27 cannot take into account effects in a different market. So while we can accept that there are many unique features that credit cards offer cardholders and merchants, such as global acceptance, convenience, the interest free period and valuable reward programmes, it is important that those features are not subsidised by customers who choose to use different payment methods. To allow market forces to play out freely and transparently, merchants needed to be given the ability to determine whether they would accept such payment methods, and if so, at what cost.
The Proceeding
The stage was set for a long and complex hearing: the trial had been set down for 12 weeks commencing in early October 2009; a special court room in Auckland, large enough to accommodate all of the parties, had been reserved; and a host of international experts from both sides were expected to give evidence.
While the Commission was confident that it would succeed at trial, it was always willing to entertain an out of court settlement provided reasonable terms could be agreed. From our point of view, a negotiated settlement would avoid costly litigation and, significantly, enable competitive forces to get to work immediately, so business and consumers could start enjoying the resulting benefits. Such benefits were otherwise unlikely to occur until the proceeding was concluded, which allowing for appeals, was likely to be some years away.
Visa was the first party to break ranks. The Commission reached a settlement with Visa in July last year and an agreement with MasterCard was reached shortly afterwards. Not surprisingly, the settlements with the schemes created strong incentives for the bank defendants to settle, and negotiations with them were concluded on the eve of trial.
Shortly after the Commission resolved its proceeding, the retailer plaintiffs also settled with the defendants, and, while we are not aware of the terms of their settlement, we hope that they may have additional long-term benefits for merchants and consumers.
Outcome of the settlement
So what exactly did we achieve?
Settlement with the schemes: As a result of the settlements with Visa and MasterCard, the following significant changes have been made to the credit card landscape in New Zealand:
MIF: Interchange fees in respect of domestic transactions using New Zealand-issued Visa and MasterCard credit cards are now to be set independently by credit card issuers in competition with one another subject to a maximum rate set by the schemes, and these rates are to be made publicly available. The manner in which interchange fees are now independently determined is unique to New Zealand - significantly, if an issuer does not stipulate or agree a fee with an acquirer, no interchange will be payable on that issuer's transaction;
No surcharge/no discrimination: The Visa and MasterCard scheme rules that previously insulated interchange fees from effective bargaining power by merchants have been disabled or amended in respect of New Zealand.
Importantly, the schemes have agreed not to enforce any rules prohibiting merchants from surcharging or using other methods to steer customers towards other payment options, including between a particular scheme's issuers or card types.
In reaching this agreed outcome, it was not a matter that the Commission was motivated to see mass surcharging of credit cards or opportunistic behaviour by merchants charging supra-competitive prices to cardholders; rather we wanted to give merchants the ability to chose what credit cards they accepted and give them the power to decide whether they would pass on the cost of accepting credit cards to the specific user, instead of being bound to indiscriminately charge all consumers for the costs of these products.
We have made it clear that if merchants choose to surcharge a transaction then the surcharge must be clearly disclosed to the customer at the time of purchase and bear a reasonable relationship to the merchant's cost of accepting a Visa or MasterCard card as a payment method.
The experience in Australia has shown us that although the elimination of the no-surcharge rule has not translated into widespread surcharging, in any event, surcharging:
increases transparency to consumers of the costs associated with the products they use; and
gives cardholders the opportunity to express displeasure to their issuer if their card product is surcharge, and thus applying further downward pressure on interchange fees.
To date, we have already seen uptake by some merchants to surcharge credit cards. Of course, the decision whether to surcharge has implications for a merchant's competitive position, so we have no special expectation around surcharging except that the threat of surcharging may allow pressure to be brought to bear on interchange fees, thereby reducing MSFs and ultimately retail prices.
Access rules: Important clarifications around the conditions of scheme membership, and particularly entry into the business of acquiring Visa and MasterCard transactions, have been made that should, over time, contribute to further downward pressure on the costs of card acceptance. Relevant for specialist and self-acquirers, the schemes have confirmed that acquirers need not also be issuers and that applicants need not be financial institutions.
Settlements with the Banks: The settlements with the schemes paved the way for our negotiations with the participating banks, who agreed to make the following commitments:
Unblending of MSF: a commitment to immediately offer merchants the option of unblended service fees, as between Visa and MasterCard transactions, enabling merchants to see more transparently the costs to them of accepting each scheme's credit cards; and
Unbundling: a commitment to offer retailers the option of fully unbundled service fees as between all types of Visa and MasterCard credit card transactions. This form of pricing, known as "interchange plus" pricing, means that merchants will see the exact amount of interchange fees and scheme or related fees applicable to each card transaction, separately from the acquirer's margin, which will assist them in negotiating lower MSFs and deciding whether to surcharge certain cards or steer consumers away from high-MIF cards and towards preferred products.
Unbundled MSF pricing is very important to allowing the new scheme rules to deliver real competitive pressure on MIF levels and MSFs. To our knowledge, these commitments are unique to New Zealand and not part of the regulated environment in Australia. While unbundling MSFs might have come about eventually in a piecemeal fashion, at least in regard to the largest and most sophisticated merchants, the settlement delivers these benefits on a guaranteed, across-the-board basis within a much shorter timeframe than would otherwise be expected.
In addition to the unbundling and unblending commitments, the banks agreed to significantly reduce the average interchange fees charged on New Zealand credit card transactions, which will ensure that these fees in New Zealand are driven down from the rates that were centrally set by the Visa and MasterCard schemes. Consistent with the scheme settlements, the banks also committed to refrain from any practices that prohibit retailers from surcharging Visa and MasterCard credit cards.
What did the settlement not cover?
There are limits on the scope of our settlement terms in that the commitments to significantly reduce interchange fees only relate to New Zealand issued credit cards. The schemes' honour all cards rules were also left intact. Visa and MasterCard had argued that the honour all cards rules were necessary to ensure that cardholders have a seamless and predictable payment experience. This was especially important given the global nature of the schemes and the fact that many travellers rely on their credit cards to pay for costs incurred on their journeys.
From the Commission's point of view, the continuation of these rules was less of a concern once the defendants had agreed to remove the restraints against merchants surcharging. So while New Zealand merchants are still required to fulfil each scheme's "universal acceptance" promise and accept all scheme branded cards, they may choose to do so in a way that will let them recover the costs of the transaction from the cardholder by way of a surcharge - provided, of course, that the surcharge bears a reasonable relationship to the merchant's cost of accepting that card.
Conclusion
The Commission's settlement with the schemes is unprecedented in international terms. To our knowledge, no other enforcement agency has achieved a similar outcome through litigation. Indeed, the US Department of Justice has been in contact with the Commission and indicated that it is very interested in the settlements negotiated by the Commission, especially because they are not the outcome of regulatory invention. Merchant groups in the United States have also used our settlements with the schemes to urge for similar outcomes (albeit through regulation) in that jurisdiction. Other competition agencies, such as the UK's Office of Fair Trading, the Canadian Competition Bureau and the European Commission, have also expressed an interest in our market-based resolution.
As a result of the settlement, we expect the savings to merchants over the next three years to be in the order of $70 to $80 million. This will be a significant reduction in the cost of doing business for merchants who accept credit cards, and, over time, we would expect to see these savings passed on to consumers through lower prices.
The Commission hopes to see competitive forces get to work in the credit card market. In particular, we'd like to see merchants take advantage of the liberalised scheme rules and use surcharging or the threat of surcharging as a way to drive down the merchant service fee. There is now the opportunity for new competitors to enter the market in the form of specialist acquirers or large retailers electing to self-acquire.
We will continue to monitor with interest the parties' compliance with our settlement and assess any subsequent changes to the competitive landscape of credit cards in New Zealand. Over time, we hope that the market-based solution we have achieved through our enforcement action can act as a useful touchstone for other countries, who are trying to foster healthy competition within their credit cards market.
I wish to acknowledge the valuable assistance given to me in preparing this paper by Charles Tingley and Roman Jewell at the Commerce Commission.
