For Visa Inc., MasterCard Inc. and competing payments networks, a more critical provision than interchange pricing remains unresolved in the Federal Reserve's proposed debit rules.
In proposing a 12-cent cap on debit interchange fees Thursday, the Fed announced it was seeking comments on two options addressing exclusive arrangements between issuers and the networks. Under either suggested course, the provision is expected to be a boost to competing PIN debit network operators such as Fidelity National Information Services Inc., Fiserv Inc. and Discover Financial Services — at the expense of Visa and MasterCard. "The ironic thing here is going into [the Fed's meeting], people thought we'd have more clarity on exclusivity than on interchange, and in fact it seems that the opposite has occurred," said Jason Kupferberg, an analyst who follows Visa and MasterCard for UBS Securities LLC in New York.
The provision, included in the Dodd-Frank Act, prohibits payments networks and issuers from limiting the number of transaction routing options on a debit card to a single payment brand's network or to two or more affiliated networks. A separate provision says networks and issuers cannot prevent merchants from choosing which available network to route over.
The issue is a bigger overhang for Visa and MasterCard, since they do not derive their revenue from interchange. Their revenue is more dependent on network fees that issuers pay them to carry their brands and process their transactions.
"The proposed routing and exclusivity alternatives put retailer profits ahead of consumer protection, choice and convenience," Visa said in a statement Thursday. MasterCard said it is still reviewing the network routing issue.
The payments networks in recent years have formed arrangements with the banks that issue their cards in which the issuers agree to use the network to process both its signature and PIN debit transactions. For example, a bank issuing Visa debit cards would use Visa's network for signature purchases and its Interlink network for PIN-based transactions.
The agreements help lock in processing volume for the payments network, which offers the bank better pricing terms.
About 40% to 50% of the debit card market in the U.S. is under exclusive routing arrangements, Tien-tsin Huang, an analyst with J.P. Morgan Securities, said in a recent research note. Visa's business is considered more at risk because it has more exclusive arrangements with issuers than does MasterCard.
The Dodd-Frank Act's language did not explicitly state whether an issuer would have to offer multiple unaffiliated network routing options for just PIN transactions or both signature and PIN transactions.
The Fed's proposals entertain both scenarios. In one, an issuer would be in compliance as long as its debit cards carry a PIN network not affiliated with the card's signature network. In the other scenario, the issuer would have to offer at least two unrelated routing options for both signature and PIN transactions.
Payments experts considered the second scenario less likely because Visa and MasterCard operate the two primary signature networks. If the Fed adopted the proposal, transactions made with a Visa debit card could be routed over MasterCard's signature network, for example, which analysts said would cause technology and branding issues for the networks.
The Fed acknowledged this in its proposal, saying that "enabling multiple signature debit networks on a debit card could require the replacement or reprogramming of millions of merchant terminals as well as substantial changes to software and hardware for networks, issuers, acquirers and processors."
But the Fed also said its first proposal could defeat one of the provision's intents, which is to give merchants more ability to route transactions over the network offering the best price. The central bank estimates that only about 2 million of the 8 million merchant locations in the U.S. accept PIN transactions, which means under the first scenario "only a single payment card network would be available" to route transactions over at those merchants.
The impact of the first option would be "benign" for issuers and payments networks, Eric Grover, the principal of the payments consulting firm Intrepid Ventures in Menlo Park, Calif., said by e-mail. "Practically, merchants would never have a choice of which network to route a transaction."
The Fed's second proposal "would upend debit network competition," Grover wrote. "The merchants would always have a choice and network fees and interchange would fall."
Kupferberg said the lack of clarity on the exclusivity provision did as much as the proposed rate caps themselves to send shares of Visa and MasterCard tumbling Thursday. The regulation could help operators of competing PIN debit networks to gain new issuers and more payments volume, analysts said.
FIS has had "more active engagement with some large institutions and some verbal agreements have been reached" to add its NYCE Payments Network to their cards, said Neil Marcous, the vendor's senior vice president of network solutions.
However, he said it also has exclusive or preferred routing arrangements for PIN transactions, which could be at risk depending on which proposal the Fed adopts.
Fiserv, which owns the ACCEL/Exchange PIN network, has said it expects issuers to add ACCEL/Exchange as a routing option on its debit cards because of the regulation. But Mike Kelly, the general manager of ACCEL/Exchange, said the Fed's meeting did little to clear up the issue.
First Data, a unit of Kohlberg Kravis Roberts & Co., did not make an executive available for an interview. But in a statement on Thursday, First Data said it could "easily make available to debit-card issuers access" to its Star PIN debit network.
Discover, which owns the Pulse PIN debit network, said this summer that it also expected to benefit from the provision.