Of Eggs and Omelets – Interchange Legislation Recipe for Disaster?

On Wednesday, July 24th, the European Commission will publish 2 widely anticipated documents. The first is the PSD II, updating the existing PSD (Payment Services Directive). The second is a new piece of proposed legislation around interchange. Interchange in Europe has long been an area of focus for the Commission, with over 30 significant investigations in the last 15 years at either country or European level. Many of these have been very public and, perhaps “personal”, with Visa and MasterCard receiving the majority of the attention. The interchange regulation therefore is anticipated with some trepidation as the Commission is seeking to draw a line under the investigations once and for all. Last week, the FT ran article based on a leaked copy of a draft of the proposal. That draft contained a range of issues, but those that have grabbed the biggest share of attention are:

• Domestic interchange rates for debit and credit to be capped at 0.2% and 0.3% respectively
• Legal separation of schemes/networks and processors

A third, but now discounted element, was a belief that these rules also applied to 3-party schemes such as Amex. So what does this mean? Firstly, the devil will be in the detail. Those of us who’ve been round the block a few times will know that drafts usually get amended before publishing – the last draft of the New Legal Framework (the original name for the PSD) had over 200 amendments between draft and final version. Many of those changes were very minor, but when every word is poured over, those differences can be very important. Secondly, these are proposals for legislation. Based on the gestation time of the PSD, even with the political will to drive this through, this will take at least 5 years to come into force, and will not be exactly as published on Wednesday. If anything, this is probably the only thing that is certain in the whole process! Some potentially significant impacts A sweeping statement (because rates vary by country, category and negotiation), but my first back of the envelope estimate suggests that the majority of the credit card volume in Europe is currently at higher rates than the proposed cap. I also believe that there are significant numbers of debit cards subject to higher rates as well – the FT suggests that debit card interchange in Poland, for example, is 1.6%. When banks are already struggling with the economics of the card already, this may result in consumers paying more having a card, and potentially, using the card. At first glance, this may seem fair – the people who use it, pay for it. But what the proposal does not seem to allow for is the fact that it’s highly unlikely that the merchants will pass on those savings, plus there seems to be a suggestion that surcharging may be allowed. The customer could potentially lose out 3 times over. That in turn creates a “ripple” effect. Banks may not offer cards to everyone and/or customers may not use the cards. After all, these are choices both parties make. At the same time, the economics of cards may have changed sufficiently that existing national debit card schemes decide to call it a day, and the economics of cards today had already killed off any chance of a home-grown debit card scheme. What we may find is that there is a move away from cards, to other payment types. As debit cards are seen as a form of electronic cash, cash is a likely winner, almost certainly not what the regulator wanted. And in certain countries, such as France, by focusing the legislation on cards, not interchange more broadly, we’ll see further growth in payment types where there are greater levels of interchange, such as cheques. Additionally, card issuers may focus on corporates going forward. Not only do they currently have greater levels of interchange already, they are not subject to the legislative proposals, plus they have much lower levels of fraud than consumer cards. In short, more money and for less risk. Whilst I understand that the regulator wants to improve transparency for consumers, and to provide them with a better deal, I feel that this legislation is more likely to make things worse, not better. Whilst, as the saying goes, you have to break some eggs to make an omelet, the regulator would seem more interested in the egg breaking rather than a successful recipe. A great chef doesn’t use a recipe, and is willing to experiment and take risks. I think this is shaping up more for a recipe for disaster.