UK Payment Systems Regulator Issues “Final Guidance” Heralding Major Changes In Operation Of Payment Systems

A View from Constantine Cannon’s London Office

By Yulia Tosheva and Irene Fraile

The UK Payment Systems Regulator (“PSR”) has published a final guidance on its approach to monitoring compliance with the EU Interchange Fee Regulation (“IFR”), which is changing the way payment systems operate in Europe.

The PSR, which was launched in April 2015, is an independent economic regulator that oversees the UK payments industry.  The PSR is the first regulator of its kind in the world.

The final guidance, which was issued on March 24, 2016, is of particular interest to payment card schemes, banks and merchants as it is the first document to shed light on the practical application of the IFR in the UK.  In view of the maturity and importance of the UK payment systems industry (currently valued at £75 trillion), the PSR’s guidance may assist other EU regulators in their implementation of the IFR.  It contains detailed provisions on the powers of the PSR to conduct investigations and to give directions, information-gathering, dispute resolution, and penalties for non-compliance.

EU Interchange Fee Regulation

The central objective of the IFR is to cap interchange fees, which are set centrally by the card schemes.  The IFR caps interchange fees at 0.2% for debit card transactions and 0.3% for credit card transactions across the EU.  Each EU Member State is given local discretion as to the level at which the caps are set within the bands specified in the IFR.  The interchange fee caps came into effect on December 9, 2015.

The caps on interchange fees are designed to redistribute revenue from issuing banks to merchants and on to consumers.  The European Commission has estimated that interchange fees amount to £1 billion per annum in the UK, although some analyses estimate that the figure could be double this.  Figures from the British Retail Consortium have also estimated that an interchange fee cap of 0.2% for debit cards and 0.3% for credit cards could save merchants in the UK some £480 million each year.

Interchange Fee Caps

The guidance includes the interchange fee caps set out by the UK Treasury.  The cap for credit card transactions is set at 0.3%.  Before the IFR was introduced, the average interchange fee charged by UK card schemes (for example, MasterCard and Visa) was about 0.8% for credit card transactions.  Some premium cards were charged at an even higher rate.  The new cap means that the average credit card interchange fee will fall by about 70%.

For UK debit card transactions, the Treasury has chosen a weighted average of 0.2%, meaning the cap will be 0.2% of the average value of all UK debit card transactions from the previous year.  As a result, interchange fees can vary for individual categories and types of transactions within a scheme.  They may be more than or less than 0.2% of the value of an individual transaction.

The Treasury has chosen not to exercise the Member State discretion to set lower caps in the UK for domestic card transactions, unlike other EU countries.  For example, since September 2014 (i.e., more than one year before the IFR came into force), Spain has applied 0.2% and 0.3% caps for debit and credit respectively, but adds an absolute seven-cent cap for debit card transactions and lower caps for low value transactions (i.e., transactions of up to €20) of 0.2% and 0.1% for credit and debit respectively.  Similarly, the Republic of Ireland has introduced a weighted average cap of 0.1% for domestic debit transactions.

Anti-circumvention

Under the anti-circumvention provisions of Article 5 of the IFR, the fees for payment transactions or related activities that the acquirer pays indirectly to the issuer are also treated as interchange fees and are subject to the caps, except where they do not have an object or effect equivalent to a direct interchange fee.  The guidance sheds some light on the application of this Article.  It clarifies that indirect interchange fees can be paid via any intermediary that (a) links the issuer and the acquirer, or (b) receives fees from the acquirer (whether directly or indirectly).  The scheme is an example of a third party that links the issuer and the acquirer, but it is not the only one.  Other intermediaries may sit between the scheme and the issuer or acquirer.  There may also be a chain of more than one intermediary that enables the issuer to receive fees from the acquirer indirectly.

Classification of Payment Card Schemes

The IFR defines two broad types of card schemes which are affected by its provisions: four-party schemes and three-party schemes.  The guidance includes the classification of payment card schemes to which the IFR applies and that operate in the UK, namely:  MasterCard, Visa Europe, American Express (Amex), Diners Club International, JCB International and UnionPay International.

Exemption from Domestic Interchange Fee Caps for Three-party Schemes Operating with Licensees

The guidance sets out the exemption from domestic interchange fee caps for three-party schemes operating with licensees.  To qualify for the exemption, the value of the scheme’s annual transactions made in the UK must be no more than 3% of the UK total.  The PSR is responsible for calculating the market shares of these schemes and deciding if they qualify for the exemption.

On March 24, 2016, the PSR published a final determination which confirmed that American Express (the only scheme operating in the UK that could qualify for an exemption) is above the 3% market share threshold and does not qualify for exemption.

Business Rules

The guidance clarifies the PSR’s interpretation of the IFR provisions concerning business rules that came into force on December 9, 2015. These provisions relate to territorial restrictions included in card schemes’ licensing agreements with issuers/acquirers (Article 6 IFR), steering rules (Article 11 IFR), and information to the payee on individual card-based payment transactions (Article 12 IFR).  The guidance explains, for example, that possible steering practices that merchants should be free to use include:

Providing information on the fees that the merchant faces for accepting different payment instruments (and different types of card);

Asking the customer to pay in a different way;

Minimum transaction amounts for a given payment instrument; and

Differential pricing (such as surcharging, or offering a discount for using a given payment instrument.

In relation to surcharging, merchants should note that when the revised EU Directive on Payment Services (“PSD2”) is implemented in the UK (no later than January 13, 2018), they will not be able to surcharge payments made with cards subject to the caps.

Monitoring and Enforcement of the IFR

The PSR will monitor compliance with the interchange fee caps in the IFR by requiring schemes and issuing and acquiring payment services providers to submit information on an annual basis, which must be certified by an independent auditor.  This exercise will not be simple, particularly in relation to domestic debit, given the option taken for weighted average caps instead of clean, “per transaction” caps.  Also, the PSR should be wary of disguised forms of interchange being imposed on merchants indirectly in the form of new fees and other, more elaborated circumvention mechanisms.  In this regard, it is important to note that the PSR will also consider information received by way of complaints in relation to compliance with the caps.  As regards compliance with the business rules (Articles 6, 11 and 12 IFR), companies will be expected to submit an initial compliance report to the PSR.  The PSR will also carefully consider any complaints.

When a regulated person fails to comply with an obligation or prohibition imposed by the PSR, the regulator may, among other measures, impose a financial penalty.  The guidance clarifies that the PSR has decided not to adopt a lower or upper limit on penalties, which will be imposed on the basis of the general principles of disgorgement, discipline and deterrence.  Also, the PSR may give directions to provide compensation or redress to a person who has suffered a loss as a result of such a failure.

Dispute Resolution

When a merchant has a dispute with its payment service provider arising under the IFR it can complain to the PSR, which can exercise its powers to resolve the dispute, including by giving a direction or taking enforcement action, where it decides that doing so would be an administrative priority.  However, the guidance clarifies that parties to a dispute are expected to have first sought to resolve their disagreements through available alternative dispute resolution processes, such as mediation, otherwise the PSR may decide to reject the application.

Next Steps

This guidance refers only to Phase 1 of the UK’s implementation of the IFR.  On June 9, 2016, the remaining Articles 7, 8, 9 and 10 come into force.  These provisions relate to important areas such as the separation of card schemes and processing entities, co-badging and choice of payment brand/application, unblending of acquirer’s charges to merchants and the limits imposed on the application of the schemes’ “Honour All Cards” rule.  Later on this year, the PSR will publish a Phase 2 consultation and subsequent guidelines addressing the issues relating to these provisions.

– Edited by Gary J. Malone