Of Card Payments, Consumer Protection, SMEs and Merchant Aggregators

Consumer advocates have raised the issue of some uncertainty about which credit card transactions benefit from the statutory right to pursue the card issuer if a merchant makes a misrepresentation or breaches the contract for sale of an item (see the April article from MoneySavingExpert). Many do not realise that the uncertainty arises from arrangements that enable small businesses to accept card payments, overlooking important benefits to SMEs and consumers alike. If SMEs (which represent 99% of UK businesses) cannot accept card payments, consumers may find it less convenient to deal with them, threatening their livelihoods and over half the UK's new jobs, while also reducing consumer choice and competition for large retailers. The statutory right is also subject to exceptions that mean the transaction might not be covered anyway. Yet cardholders still have 'chargeback' rights under their card terms, which are more generous and involve less hassle than making a statutory claim.  So, my own view is that the benefit of enabling small traders to offer their customers the convenience of paying by card outweighs the potential lack of a statutory claim against the card issuer, because the cardholder has the greater comfort of being able to initiate a chargeback anyway. 

Statutory Rights

Consumer credit transactions that involve the borrower (e.g. a credit cardholder), the creditor (e.g. a credit card issuer) and a supplier (merchant) under the same agreement benefit from a provision of the Consumer Credit Act (CCA) that makes the creditor liable for any misrepresentation or breach of contract relating to the sale of the item (section 75). Various exclusions apply. For instance, it only covers items over a £100 up to £30,000 and it does not cover or must be more than Another provision covers transactions where the credit agreement did not directly involve the supplier but was specifically linked to the sale of a specific item (section 75A). Again, however, there are exceptions and it only applies to transactions for an amount exceeding £30,000 up to £60,260, so it is unlikely to be relevant to card transactions.

Chargeback Rights

Under rules governing the operation of the card schemes, such as MasterCard, card transactions can be reversed or 'charged back' in various cases including cardholder dispute within 180 days of the transaction. This right is wider than the statutory right under section 75 of the CCA because it applies to debit card transactions as well as credit card transactions, and the reasons for initiating a chargeback go well beyond the scope of the statutory right (see the list of reasons on page 54).

Merchant Aggregators

Card schemes operate by enabling issuers to issue payment cards that can be presented to participating merchants, who send the transaction data to an 'acquirer' who then obtains payment from the relevant card issuers via an 'interchange' process run by the card scheme operator. 

Typically, the merchant must have a direct contract with an acquirer, but that is expensive to set up and administer in the case of small merchants. 

So to give cardholders the convenience of being able to pay small merchants, the card schemes allow approved intermediaries (MasterCard calls them "Payment Facilitators", for example) to represent  small businesses more efficiently and cost effectively under a single contract with the acquirer, enabling those 'submerchants' to accept card payments where their annual transaction volume is less than $1m or local currency equivalent (increased from $100,000 a few years ago). WorldPay, the UK's largest card acquirer, explains its aggregator program here, for example; and MasterCard has a global list of approved Payment Facilitators by region.

In addition, department stores and e-commerce marketplaces may be treated by the card schemes as the merchant, where the obligation to pay the price of an item offered by a third party seller is satisfied by paying the store or marketplace operator rather than the seller directly. Where problems arise in that context, even though section 75 claims would not be possible, the cardholder typically has the right to either use the marketplace's own dispute resolution and compensation process or, in any event, to initiate a chargeback (large third party sellers will also have their own returns and complaints resolution and compensation process). Such 'master merchant' relationships are also important channels for small businesses to gain access to larger markets, again improving convenience, consumer choice and competition.

The point in all these cases is to weigh the benefits to consumers of convenience, increased choice and competition - as well as the benefits to SMEs who are able to access a wider market, grow and create more new jobs - against the loss of the relatively narrow rights under section 75 compared to chargeback rights and other remedies.

Cardholders Don't Seem All That MIFfed... Yet.

At long last we have a judgment in the MasterCard interchange case. And if the strength of MasterCard and the UK banks' resistance is anything to go by, you might've thought the impact will be profound. But does the decision really threaten the reign of credit and debit cards as the dominant retail payment method in the UK?

In essence, the multilateral interchange fee (MIF) is a share of every credit or debit card transaction that is retained by the bank that issues the card. As previously explained, we all end up paying for MIF, because it's passed through in the charge to retailers for the ability to accept card payments (see here for how card acquiring works generally). 

The saga of complaint, denial and escalation over MIF seems even worse than the Great PPI Robbery, which definitely ended badly for the banks. The first complaints about the anti-competitive nature of MIF were made to the European Commission by trade bodies representing retailers in 1992 and 1997 respectively. To escape allegations that the banks had a common interest in maintaining the MIF, MasterCard's member banks went so far as to agree to float MasterCard Inc. as a separate company on the New York Stock Exchange in 2006. This did not convince the Commission. On 19 December 2007, it outlawed MIF. In response, MasterCard (tellingly 'supported' by former member banks as "interveners" in the proceedings) applied to the European Court of Justice to overturn that decision on 1 March 2008. It has taken over four years to get a judgment dismissing their application. Only a limited appeal on points of law is possible.

The Commission had decided in 2007 that the MIF set a floor below which merchant service fees would not fall, and so restricted price competition to the detriment of retailers. It considered that the absence of a MIF would also reveal any bilateral interchange fees agreed between specific issuers and acquirers, making the acquirers' service obviously more expensive, and exposing them to competition. The Commission rejected the idea that MIF paid for various 'efficiencies' that justified its anti-competitive effect. It also considered that the issuing banks had tried to justify the MIF by including costs that are also inherent in other forms of payment, such as the costs of maintaining a current account...

The Court has now agreed with the Commission. Both believe that MasterCard and the card issuers make so much money out of their payment card businesses that the loss of the MIF won't significantly impact the scale of their activities, or their ability to drive cardholder demand. In particular, the Commission found that "issuing banks generated 90% of their revenues with income from cardholders (mainly [interest]) and only 10% from interchange fees." Debit card payments also drive cost savings for the banks by reducing the number of more expensive cash and cheque transactions they needed to handle. And a significant reduction in MIF in Australia did not have any of the effect the banks claimed an outright ban would have here. In fact, the Court found that to determine the level of MIF for credit and charge cards, MasterCard tries: 

"...to answer the question: “How high could [MIFs] go before we would start having either serious acceptance problems, where merchants would say: we don’t want this product anymore, or by merchants trying to discourage the use of the card either by surcharging or discounting for cash”’.

From the nature of this equation, the removal of MIF should mean lower costs to merchants, who can use these savings to invest in increased selection, to improve customer experience, to expand - or to simply survive in the current downturn. Those merchants who merely take the lower overhead as profit are clearly in a good position, and I guess there's a chance they may one day face their own competition investigation, but that's an entirely separate issue as I've pointed out before.

That's good news for consumers generally. But what of the impact in the market for new payment methods amongst cardholders themselves? What will prevent card issuers from reducing the value of loyalty schemes or otherwise charging cardholders more in interest and/or fees to make up for lost MIF income?

Interestingly, MasterCard and the banks said that removing MIF would mean "a move towards alternative products or services." But the Commission believes that consumers' strong preference for card payments means the pressure of other payment methods has been too weak to make any difference to the level of MIF (and therefore card issuing and acceptance). As mentioned, removing MIF should actually make card payments cheaper for merchants, so make them less inclined to explore alternatives. In those circumstances, a cardholder rebellion would seem difficult to achieve.

So while the ability to "extract rents" via the MIF has been curtailed, the dominance of cards as a payment method may be sustained. Indeed, card issuers may believe the strong consumer preference noted by the Commission allows them to compensate for the loss of MIF by raising interest rates and charges for cards. That would avoid the need to dip into interest income for the marketing budget to keep stoking demand in the midst of a downturn, pressure to repair bank balance sheets and Basel III capital constraints that attach higher risk-weightings to consumer lending. Such increases could happen soon. The Commission originally gave MasterCard 6 months to remove MIF and this timeline may be insisted upon. But card issuers might well try to raise interest rates and/or direct charges in advance of that date, pointing to the cost of systems changes to remove MIF as instructed.

Ironically, it would seem that we cardholders only have ourselves to blame for such a scenario.

It remains to be seen how high interest and charges on card payments will need to go before we'll rebel.

Image from GAO report on interchange.

How Card-based Merchant Acquiring Works

The requirement for the European Commission to review the operation of the Payment Services Directive provides a great opportunity to consider, amongst other things, how card-based merchant acquiring works. I've explained my take on it in an article for SCL, complete with a you-beaut, funky graphic: 

How card acquiring works

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