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This story appears in the December 2008 issue of Cards&Payments.
The payments industry this year faced new pressures from a tougher economy, legal and regulatory scrutiny of card issuers' practices, and the rumblings of interchange legislation that eventually could change the business model for credit and debit cards. Adding to the sense of anxiety is that technology failed to deliver hoped-for breakthroughs, particularly in mobile payments.
The following is a look at some of the key payments-industry issues in 2008 that could have long-term implications:
Interchange
The long-simmering dispute between card issuers and merchants over interchange came to a boil this year, with interchange-rate legislation introduced in the U.S. and renewed debate occurring elsewhere. Merchant acquirers pay interchange to card issuers to cover the cost to provide card programs and then pass the expense on to their merchant clients as part of the discount rate. In many countries, interchange also generates a significant portion of card issuers' profits.
Interchange rates in the U.S are among the highest in the world, averaging about 1.7% of the sale, and merchants complain they pay more than $42 billion annually in fees over which they have no control. In response, lawmakers in March introduced the Credit Card Fair Fee Act in the U.S. House of Representatives. The bill would require credit and debit card networks on behalf of issuers to negotiate new interchange rates with merchants under a federal judge's supervision.
The House Judiciary Committee approved the legislation in July, though the bill remains stalled in the House. Observers believe it likely will resurface next year.
Payment networks, including MasterCard Worldwide, and the American Bankers Association say the bill amounts to price-fixing and ultimately would result in higher prices for consumers.
European issuers also face reductions in interchange revenue. MasterCard in June suspended interchange on all cross-border transactions at the behest of the European Union Competition Commission, which deemed the rates anticompetitive. Some European merchants say some acquirers continue to pocket the cross-border interchange portion of the discount rate instead of passing on the savings to retailers.
MasterCard has appealed the commission's ruling, and some acquirers say they will pass the savings on to merchants only if MasterCard loses the appeal.
In the land Down Under, the Reserve Bank of Australia in September announced that if the card industry there can devise a new approach to setting interchange rates that is fair and competitive, it may remove credit card regulation that caps interchange at 0.5% of the sale. The bank will decide next August whether to continue the regulation or reduce the interchange rate further to 0.3% of the sale, depending on how the industry responds to its proposal.
Duncan Douglass, a partner with Atlanta-based Alston & Bird, says it is too early to say who benefits most from interchange regulation. "Whether or not interchange regulation causes a reduction in consumer prices is disputed," he says.
Issuer Policies
U.S. card issuers faced another potentially serious challenge, as Congress and federal regulators moved to crack down on certain longstanding credit card business practices some lawmakers deem abusive.
The Credit Cardholders' Bill of Rights, introduced in the U.S. House in February, would prevent "any time, any reason" repricing for interest rates on outstanding balances and would give cardholders more time to pay their bills before incurring fees, among other provisions. It passed in the House by a decisive margin in September but made no further progress before Congress adjourned for the year.
Key provisions of the bill mirror those of new credit card-industry rules the Federal Reserve, the Office of Thrift Supervision and the National Credit Union Administration proposed in May. The rules outlined by the Fed would prohibit issuers from raising the interest rates on cardholders' outstanding balances unless the balance is tied to an index or variable rate, if a promotional rate expires, or the issuer does not receive a payment within 30 days of the due date. Issuers also would apply payments first to cardholders' highest interest-rate balances, and they would extend the payment cycle to 21 days from the current 14-day average.
The Fed received more than 61,000 public comments on the proposed rules–a record by a long shot–mostly from consumers outraged over seemingly unfair increases in interest rates and fees. Card issuers protested that the Fed's proposed new rules, if enacted as outlined, could hobble their ability to price card offers based on individuals' risk profiles and likely would result in fewer overall credit card offers for consumers.
The Fed expects to finalize the new rules this month.
"If most of these rules are enacted as outlined, they could have a chilling effect on line-of-business investments for issuers," says Bruce Cundiff, a senior analyst with U.S.-based Javelin Strategy & Research. "There is no doubt that issuers must tread more carefully and reassess some of their practices."
Visa Inc. launched its initial public offering in March, netting $19 billion in what was said to be the most-lucrative IPO in U.S. history.
Card Brand Moves
The deal set in motion a new era of competition among card-network rivals unfettered by their former bank-association limitations, watched closely by investors, analysts say. Visa's rivalry with MasterCard, which went public in 2006, ratcheted up sharply, especially in terms of battling for credit and debit card market share in light of recent bank mergers.
"The competition between the card networks became very interesting this year, with a lot more negotiation going on behind the scenes on rates and fees and services the networks might provide to issuers," says Adil Moussa, an analyst with Aite Group.
American Express Co. opened its network for the first time to third-party processors, beginning with a deal struck late last year with First Data Corp., followed by another deal in January with Heartland Payment Systems. Although AmEx retains the contractual relationships with the merchants and sets the merchant discount rate, the strategy is designed to enable more small and medium-size retailers to accept AmEx cards alongside the other major credit card brands.
AmEx would not discuss the effects the new processor deals have had on its ability to increase merchant acceptance of its cards.
Discover Financial Services, which began opening its once-proprietary network to third-party transaction processors in 2006, claimed to have inked processing agreements with 80 independent sales organizations and processors, including the nation's top 10 merchant acquirers.
Unlike AmEx, Discover has handed over control of the contracts and fees to the processors, so merchants can add Discover acceptance alongside Visa and MasterCard with little effort and no additional cost. When the majority of the agreements kick in this year, Discover predicts it will have 98% acceptance parity with Visa and MasterCard.
To further extend its global-acceptance reach, Discover in April acquired Diners Club International from Citigroup for $165 million in cash. The deal added to the Discover Network 8 million acceptance points in 185 countries. Existing licensees such as Citi will continue to issue Diners Club cards, but Diners Club transactions previously handled by a hodgepodge of processors will migrate over the next year or two to the Discover Network, which Discover hopes to build into a lucrative channel.
"Discover has made some great strategic moves in trying to catch up with MasterCard and Visa on the acceptance side, but it has a lot of work to do in terms of getting people to use the cards," Moussa says.
AmEx and Discover this year resolved their bitter antitrust battles initiated in 2004 against Visa and MasterCard. AmEx and Discover each received billions in damages for harm Visa and MasterCard allegedly caused with exclusionary rules that for years prevented their member banks from issuing AmEx and Discover cards.
Contactless Initiatives
Delays pushed back the timetable for widespread availability of contactless mobile payments supported by Near Field Communication technology. French telecommunication brand Orange had expected to roll out NFC payments on a small scale this year. It now says problems have moved the launch into next year.
Telcos and other industry forces this year finally have reached agreement on standards for subscriber identity module (SIM) cards that likely will drive development of mobile phones that support mobile payments.
"SIM cards have emerged as the front-runner for mobile-payment technology, and although many underlying issues about the business models that might emerge have not yet been resolved, that is progress," says Ed Kountz, senior analyst for payments and financial services at JupiterResearch, a unit of Forrester Research.
Estimates now call for widespread availability of mobile payments-ready NFC phones by 2012 or 2013, he says.
Contactless-payment deployments proceeded in fits and starts, but despite claims of convenience by card brands that it enables consumers to tap cards or devices for faster payment transactions, it has failed to achieve widespread success in most markets.
Total contactless cards on issue in the U.S. will top 100 million this year, which includes about 10% of all cards in circulation, but only 1% of card-accepting merchants nationwide have contactless readers, preventing broad usage by consumers.
Closed-loop contactless payments in Japan have proved popular with consumers, but most efforts lack broad marketplace applications.
Contactless-payment stickers also emerged this year as a possible interim strategy to get consumers into the habit of paying with phones instead of cards. First Data in August demonstrated its prepaid Go-Tag contactless sticker at the Democratic National Convention. Heartland also is using contactless stickers on college campuses.
"Our numbers indicate consumers understand the value of contactless once they've been able to try it, but more marketing to drive awareness is needed," Kountz says.
SEPA Goes Live
In Europe, the Single Euro Payments Area initiative went live in January, with banks processing credit transfers in the first phase of the process to create a common market for electronic payments. More than 4,100 banks, representing 95% of European e-payments, are in compliance with SEPA credit-transfer requirements.
But direct-debit payments, still confined mostly to domestic payment programs, lag behind. Experts say debit may not achieve SEPA compliance until after their November 2009 deadline, and SEPA cards will be late, too. And it remains uncertain whether an alternative debit-payment scheme for Europe will emerge to compete with Visa and MasterCard, which today remain the only "universal" option for cross-border transactions in Europe.
Legal and legislative challenges in 2008 cast a shadow on card-issuer practices and the interchange business model, suggesting changes may be ahead that could reshape aspects of the card industry. Although progress in mobile and contactless payments fell short of some expectations, the groundwork was laid this year for possible breakthroughs in the future. CP
