Importance of correctly functioning card-acquiring market in post-COVID-19 economy
The market review was launched well before the ‘extraordinary [economic] impact’ of the COVID-19 pandemic began to be felt. However, in its final report the PSR makes the point that the COVID-19 induced acceleration of well-established trends such as the growth in card payments, changing shopping preferences (including the shift to online spending) and increasing levels of card acceptance among (small) businesses means that it’s even more important for the supply of card-acquiring services to work well for merchants going forward.
Impact of the Interchange Fee Regulation (IFR)
The IFR, which came into force in 2015, capped interchange fees on most card transactions, but did not drive down overall prices because interchange fees are only one element of the overall merchant service charge (MSC) that merchants pay their card-acquirers. As well as interchange fees, the MSC is also made up of scheme fees (paid to the operator of the card payment system e.g. Mastercard or Visa) and the acquirer net value (this covers the acquirer’s other costs and margin). Rather than capping the MSC, the IFR relied on competition between providers of card-acquiring services to ensure that the cost savings they realised were passed through to merchants.
The PSR believes that further action is needed as acquirers do not pass on the savings they make from the IFR caps to merchants.
The PSR’s analysis concluded that over the period 2014-2018 scheme fees paid by acquirers to Mastercard and Visa had increased significantly and a substantial amount of these increases are not explained by changes in the volume, value or mix of transactions.
The PSR used two broad merchant segments within the supply of card-acquiring services to structure its analysis:
- Small and medium-sized merchants with annual card turnover up to £10 million. Almost all merchants are in this segment, although they are only responsible for around 17% of the value of card transactions. The smallest merchants within this segment, with annual card turnover up to £380,000 make up around 90% of the overall merchant population.
- Large merchants with annual card turnover above £10 million. This segment is dominated by a very small number of the largest merchants, with annual card turnover above £50 million, who are responsible for around 76% of the overall value of card transactions.
Summary of findings
Small and medium-sized merchants
The PSR concluded that small and medium sized merchants face the following issues:
- Pricing issues: on average, these merchants received limited or no pass-through from IFR savings.
- Loyalty penalty: new customers were likely to pay less on average than existing customers.
- Negotiation successful when tried: almost 90% of those merchants who tried to negotiate with their provider successfully got a better deal.
- Unlikely to switch provider: Despite having a variety of providers to choose from, many small and medium-sized merchants don’t search for providers and rarely consider switching. This could discourage acquirers wanting to serve particular merchant segments from entering the market and expanding competition, and may have the effect of weakening competition between existing providers.
The PSR identified several barriers to switching:
- Lack of transparency: Acquirers and independent sales organisations do not typically publish prices for card-acquiring services. In addition, their pricing structures and approaches to headline rates vary significantly. This makes it difficult for a merchant to compare prices in the market.
- Indefinite contracts: Contracts with acquirers and payment facilitators for card-acquiring are for an indefinite period which could mean there is no clear trigger for a merchant to (1) think about searching for another provider who might provide better value or (2) negotiate with their existing provider.
- POS terminals and contracts: POS terminals and POS terminal contracts that prevent or discourage merchants from searching for and switching to a new provider. This can occur because a merchant typically cannot use its existing POS terminal with a new card-acquirer. If it changes its card-acquiring services provider it may need a new POS terminal and to cancel its existing POS terminal contract – which can result in a significant early termination fee. POS terminal contracts can have different renewal terms than contracts with card-acquirers and may automatically renew for successive fixed terms which also makes it difficult to terminate a contract for card-acquiring services.
The PSR is confident that remedying these features will improve outcomes for small and medium-sized merchants.
- Market not working for large merchants with annual card turnover between £10 million and £50 million: Just like small and medium-sized merchants, large merchants with annual card turnover between £10million and £50 million, on average, got little or no pass-through of the IFR savings. The features which restrict the searching and switching behaviour of small and medium-sized merchants also apply to this group.
- Larger merchants with annual card turnover above £50 million: The largest merchants, received full pass-through of the IFR savings, and the PSR estimates that the benefit of the savings to these merchants was around £600 million in 2018. Although the largest merchants can face significant switching costs (due to having to integrate complex systems), they generally achieve good pricing outcomes and the PSR did not find any evidence of the market not working well for these clients.
Potential remedies – any clues?
Although the PSR plans to publish a separate remedies consultation in early 2022, there are some clues on the types of remedies the PSR may suggest. These could include:
- requiring greater transparency in relation to pricing;
- reducing complexity of pricing structures to enable easier comparison across different providers;
- compulsory end dates in card-acquiring contracts or “prompts” to encourage merchants to consider switching; and
- measures to ensure that POS terminal contract terms are the same length or shorter than those of the merchant’s card-acquiring service contract.
Now that the PSR has set out its concerns, it plans to publish a remedies consultation in early 2022 setting out its views on the most suitable remedies. The PSR expects industry play a key role in developing remedies which will increase merchant engagement and ultimately improve choices and prices.
Following the remedies consultation, the PSR will publish its provisional decision on remedies (and potentially a draft remedies notice) for consultation later in 2022. Change is clearly on the horizon but, given all the work to be done in 2022, it’s probably unlikely that any remedy provisions will come into effect before 2023.
Please get in touch with any of the listed contacts if you would like to discuss the potential impact for your business.
Authored by Neelam Hundal, Julie Patient and Virgina Montgomery.