Wary ISOs and acquirers are putting hiring and other plans on hold as they await the Federal Reserve Board's final version of new debit card interchange rules, which likely will reconfigure their revenue streams.
Although the full ramifications of the new pricing and network-routing schemes Congress mandated will not be clear until the Fed issues its final rules, so far it is obvious that the Fed will cut debit-interchange rates sharply. The cuts also likely will reduce the portion of the discount rate acquirers pay ISOs and cause other business-process issues for acquirers and processors, industry insiders predict.
In any event, ISOs are bracing for pain.
"If the Fed puts a hard cap on debit-interchange rates, I will probably have to lay people off," Jay Holsomback, president of Secure Payment Solutions Inc., a Tyler, Texas-based ISO with eight full-time employees and up to a dozen part-time and contract workers, tells ISO&Agent. Holsomback in late December posted his comments on the proposed rules on the Fed's website; the comment period ends Feb. 22.
One of the Fed's two proposals calls for issuers to set debit interchange rates at a baseline of 7 cents per transaction plus any additional costs for authorization, clearing and settlement, up to 12 cents, as long as the issuer provides expense reports.
A second proposed option simply allows issuers to set debit interchange rates at 12 cents or less per transactions.
For a typical $40 PIN-debit Interlink purchase, the interchange fee for retail merchants now ranges from 30 cents to 45 cents, depending on volume, according to ISO&Agent calculations using Visa Inc.'s published rates.
The Fed says it will publish final rules on debit interchange pricing on April 21, and the rules would go into effect July 21.
The board also proposes to limit debit-network exclusivity. Under one option, a card network would have to ensure a debit card transaction could be carried on at least two unaffiliated networks that could include one signature-debit network and one PIN-debit network. Another option would require networks to provide at least two unaffiliated signature-based debit networks and two unaffiliated PIN-debit networks.
The Fed has said it will issue a final decision on the routing options in July, and it has not provided a date for implementation of the final routing-options rules.
A Complicated Business
As ISOs and acquirers cope with changes, merchants also may begin to feel pain, particularly if the new economic model eventually leads to the end of free payment terminals and complimentary service and supplies for merchants, Holsomback says.
"If our profit margin goes away under the new rules, we won't be able to afford to provide a lot of services merchants have come to take for granted," Holsomback says. "We are part of a complicated business that Congress, and many merchants, fail to fully comprehend."
But the Fed's new rules could usher in a new era of greater competition and innovation that could spawn a more efficient and safer payments system, some observers believe.
"ISOs, acquirers and processors are going to have to wake up now and start coming up with real improvements to the system, such as finding better ways to prevent fraud, and ending unnecessary middlemen and mark-up costs," says Steve Mott, a principal at BetterBuyDesign, a Stamford, Conn.-based payment consultancy. "There are guys that have been feeding at the trough of the payments industry for years who will find out now that the Fed has set a new table, with not as many chairs and not as much room for everyone."
Merchants generally agree that change is long overdue (see story below).
Card issuers will feel the biggest effects of the Fed's policy changes. The proposed rates would result in a loss of $11.8 billion in their revenue. Large issuers would see their debit card revenue drop by an average of 73% per transaction, making debit cards "significantly unprofitable," according to a Dec. 22 report from Oliver Wyman Group.
Without knowing the final version of the pricing and routing rules, and lacking vision on how the card networks will choose to implement the rules, it is difficult to predict the full magnitude of the economic impact of the new debit regulations on the ISO and acquiring industries, says Mary Bennett, director of government and industry relations at the Electronic Transactions Association.
One of the biggest concerns for ISOs and acquirers will be potential changes to systems and business processes, she tells ISO&Agent.
"It is conceivable that ISOs and acquirers may have to amend the procedures used in boarding new merchants, revamp the way rates are calculated and reported, and modify hardware and software used in payment processing from the (point of sale) to the back end," Bennett says, noting that it is impossible to estimate the potential costs of such changes without knowledge of the final rules.
From an acquirer's standpoint, the biggest concern on debit card interchange pricing changes is whether the final rules will call for a uniform interchange rate or different rates for large banks, says Greg Cohen, president of the U.S. arm of Canada-based processor Moneris Solutions Corp.
"The regulations are open to the option of different banks qualifying for different rates based on their internal costs for handling debit, which could potentially lead to unique price scales for different institutions," Cohen says. "This would be a massive challenge, possibly requiring hands-on changes at the terminal level, as well as programming changes and possibly ongoing needs for updating and managing rates that might change."
Minimize Damage
The debit-interchange pricing changes also could open up new opportunities for ISOs and acquirers if demand for PIN-debit increases.
If some banks eliminate signature-debit programs in the wake of lower pricing, there could be a rush to add PIN-debit terminals at small to midsize merchants nationwide, Cohen speculates. Only 15% to 20% of small merchants deploy PIN pads, he estimates.
"Outside of supermarkets, petroleum retailers, convenience and big-box retailers, there are not a lot of PIN-pad terminals out there, and in e-commerce it's almost unheard of," Cohen says. "A widespread movement to PIN-only debit would be a problem for merchants, and it could be an opportunity for ISOs and acquirers," he suggests.
The changes to the debit-network routing rules also could have onerous consequences for acquirers and processors, Cohen says.
If the Fed were to require two unaffiliated networks each for signature-debit and PIN-debit transactions, it could cause "a huge problem" for processors that would need to do significant reconfiguring of authorization processes, possibly even replacing payment terminals, he says.
"It would be a tremendous challenge for everyone to bring the merchant community up to the level of offering two unaffiliated networks each for signature and PIN debit, and I can't see who would foot the bill or how such an investment would pay off," Cohen says.
However, if the Fed requires debit cards to support only two unaffiliated networks for signature and PIN-debit transactions, implementation would be much simpler, he suggests. "Simply requiring one unique signature and PIN-debit network each on a card would minimize the collateral damage," Cohen says.
Some of the industry's largest acquirers and processors, including First Data Corp., declined to comment on potential outcomes for ISOs and others resulting from the new debit-interchange rules. But in the immediate future, debit-interchange rules could be a wash, or they could provide a short-term windfall for ISOs, acquirers and processors, some observers suggest.
Paul R. Garcia, Global Payments Inc. chairman and CEO, told analysts during a Jan. 6 conference call to discuss company earnings that he does not foresee a negative effect on the processor's revenue. Those acquirers not passing along their entire debit-interchange costs will see a pick up in revenue, but in doing so they could face repercussions, Garcia said.
A Thin Margin
"We're going to be very cautious because it is not only a very competitive market, (but) you don't want to invite regulations of something," he said, noting that at least one Global Payments competitor is saying it will pass along the entire reduction.
ISOs could retain a portion of the revenue above 12 cents if they do not lower their merchant pricing, Garcia said.
But fierce competition among ISOs ultimately would undermine that revenue, Holsomback contends.
"Merchants will probably demand lower pricing soon after the rules are finalized, which will unleash a lot of competition among ISOs to recruit new merchants under the new pricing structure, which will be catastrophic to our already thin margins," he says.
ISOs possibly could find new revenue by helping to push more debit PIN pads into the marketplace, or by assuming a key role in helping to sell and expand emerging mobile-payment schemes that could include added-value services, such as merchant-coupon programs, Mott suggests.
"The Fed's mandate is going to force players in the payments industry to modernize the electronic-payments industry, which has been clinging to the status quo for far too long," he says.
Such efforts are only theoretical and are not necessarily supportive of a long-term business model, Holsomback says.
"As an industry, ISOs and acquirers have not done a good job of educating merchants on the services we provide, and now we're at a disadvantage," he says. "We provide 24-hour service to help merchants with a host of problems that happen at the point of sale; we provide new terminals, maintenance charge-back coverage and even the paper merchants use for receipts, all out of our pocket. A lot of that will have to go away under the proposed debit-interchange cap."
While the industry awaits the Fed's final rules, ISOs, issuers and acquirers are in a holding pattern, considering how their businesses might change under new debit-interchange pricing and contemplating the next moves.
