There is a growing movement towards domestic processing of payment transactions across Asia, mirroring trends in markets across the world. Japan’s JCB and China’s CUP have also demonstrated they are not content with their own markets, branching out internationally. Richard Hartung reports.
Ever since they were founded more than four decades ago, MasterCard and Visa have been both dominant brands and transaction processors throughout much of Asia.
While a few large Asian markets have had domestic transaction processing, the card schemes switched transactions domestically as well as internationally between banks in many countries.
Now, however, a major shift in the process for switching and clearing domestic transactions is underway. Markets throughout South and South-East Asia are developing domestic clearing systems to switch transactions; those with a huge domestic market such as China UnionPay (CUP) are gaining clout not only in their home market but also globally through partnerships with other local switches.
At stake is potentially hundreds of millions of dollars of revenue, and those transactions are turning into a tussle involving governments as well as corporate giants.
Domestic processing in the last decade
While some markets have long had domestic switching and clearing systems, with the value-added networks (VANs) like Nice in Korea and also CAFIS in Japan being notable examples, the transition towards domestic processing in other markets began in earnest only a decade or so ago with the rise of CUP.
Since its launch in 2002 to switch and settle card transactions domestically in China, China UnionPay (CUP) has become a powerhouse and by 2009 switched the vast majority of the 16.7bn bankcard payment transactions in China.
For a combination of reasons ranging from a desire to move quickly in adoption of electronic transactions and perhaps observing the success of CUP to cost and standardisation, other countries in the region have also started to look at setting up a domestic switching system and have been moving along a similar path over the past several years.
In 2008, for example, the Indian Banks Association set up the National Payments Corporation of India and announced that they would set up IndiaPay. Thailand and Malaysia also started moves toward domestic processing, and other countries are considering similar initiatives. In some other markets a different path sees more transactions switched bilaterally between merchants and card issuers, bypassing a domestic or international switch altogether.
The impact of these changes on the card schemes can be quite significant. Instead of moving across the MasterCard or Visa networks, more domestic transactions would flow along lower-priced networks. The card schemes could be left as processors of international transactions, which average around 5% of volume in many markets. Not unexpectedly, industry insiders interviewed by BPA, sister publication of CI, preferred to remain anonymous as they discussed the potential impact of these developments on their markets.
Cost a key push towards domestic
A variety of factors have provided an impetus for this move towards domestic transaction processing.
One of the key factors, not unexpectedly, is cost. While the card schemes do not publish fees in most of the Asia Pacific region, costs are large and reportedly rising. Local reports estimate the fees paid to MasterCard and Visa for clearing and settlement in India at over $100m per year. Reserve Bank of India (RBI) data showed just about 395m payment transactions in 2009, compared to about 3.5bn in Australia and 16bn in China, so it is easy to see that fees in other markets could be more sizeable if transactions go across card scheme networks.
A second factor propelling the change is operational efficiency especially when there is a strong government-backed to develop electronic payments at a domestic level. CUP, for example, says that it was set up for “joint stipulation of rules, joint popularisation of business, joint expansion of market and joint standardization of orders”.
RBI said in its Payment Systems in India report in 2005 that a local clearing system would help to overcome inefficiency caused by multiple operators, “local practices which vary from place to place” and customer service which is “often compromised for operational convenience.” Especially in larger markets, increased efficiency of a local clearing system is also viewed as a way to hasten the move from cash towards electronic payments.
Another factor more recently has been the rapid increase in card scheme debit cards. Some markets already have local switches for processing domestic or proprietary debit cards. As banks have started to issue MasterCard or Visa debit cards, or converted their local debit cards to scheme cards, more transactions have flowed across the card scheme networks – sometimes at a higher cost.
With the growth in debit rapidly outpacing credit and expected to rise even further, banks in some markets may have faced increasing costs and started looking for alternatives.
Increasingly vocal card schemes
Although the card schemes have previously worked in a low-key manner to increase acceptance of their own brands and their processing of domestic transactions, their objections to the development of domestic switches have become more prominent over the past year as the impact onto their local business in key Asian markets cannot be ignored.
In March 2010, according to Bloomberg, the US Trade Representative was in the midst of deciding whether to file a suit at the World Trade Organisation (WTO) to push for American Express, MasterCard, Visa and other card schemes to be able to process transactions in China.
“My preferred course of action is always… direct negotiations,” US trade representative Ron Kirk told reporters. “[If negotiation proves fruitless] we can make a decision at an appropriate time… whether we want to file a law suit.”
A review of whether to file at the WTO is apparently still under consideration.
Visa decided to take unilateral action against CUP in June when it told its clients that transactions outside China on cards with both the Visa and CUP logos should be switched across the Visa network rather than CUP.
According to ChannelNewsAsia, CUP said in its response that transactions on the CUP network do not incur foreign currency mark-ups, so the transactions are less expensive for travellers, and “neither party has the right to unilaterally restrict cardholders’ options for overseas payment channels”.
While other card schemes have not taken similar actions yet, objections could spill over to other companies. Other markets could also do something similar to Taiwan, which has a button on the terminal so that cardholders can specifically select to have the card routed via CUP.
Markets moving in parallel
In Northeast Asia, most markets have developed local systems to switch domestic transactions. China UnionPay in China, CAFIS in Japan, VANs in Korea and NCCC in Taiwan process a significant portion of the transactions in their respective markets.
To the south, local switching also exists in New Zealand. An industry source said “about 70% of transactions in New Zealand are on debit cards and about 70% of those transactions are switched by Paymark”, so there is already an alternative to the card schemes. Debit transactions in New Zealand that do go across the Visa or MasterCard network reportedly incur a negotiated fee lower than in some other markets.
It is in South and South-East Asia as well as Australia, where local switching has been less common, that some of the largest changes are now happening. India, Malaysia and Thailand are in the middle of developing local clearing networks. In other markets the pace is slower, though plans reportedly could be under consideration soon.
The development of local clearing in more countries within Asia-Pacific means domestic transactions in an increasing number of markets could move from card scheme networks to domestic networks.
Industry observers in the countries developing a domestic switch indicate that financial institutions could save anywhere from tens to hundreds of millions of dollars per year by shifting from card scheme to local networks. With such a move already starting in India and Malaysia and Thailand, it’s easy to see how other countries in the region could follow suit, even if they haven’t started work on it yet.
One uncertainty is how the card schemes would react and what the implication for overall fees would be. Card schemes obtain revenue from a combination of local processing, international processing, brand assessment, foreign exchange and other fees. If transactions moved from card scheme networks to local networks, some industry executives speculate that the card schemes could attempt to increase the brand assessment fees to make up for the loss.
The card schemes could also attempt to require local transactions to flow across the card scheme networks, similar to how Visa has announced that cards carrying its brand should flow across its network rather than China UnionPay’s.
If significant changes in fees did start to occur, regulators or legislators could require that transactions move across the domestic network and they could place limits on fees. Taiwan, where one banker said regulators require “Taiwan-dollar-denominated and not-on-us transactions by Taiwan-issued credit cards” to be settled by NCCC or FISC, provides one example.
An alternative could be a situation like in New Zealand where, say industry insiders, interchange rates are low because of the potential for mandates to be put in place if the card schemes do not have special pricing for New Zealand.
One card scheme insider said the scheme is “scared, especially if the regulators get involved”, and there are many discussions internally about how to proceed regarding the new switches.
Moreover, some international transactions could move to CUP if other card schemes’ fees increase. BC Card in Korea is “livid” about increased fees there, said one industry expert, and more of their transactions have moved to CUP. Other companies could follow that pattern.
Another effect of local processing could be increased card usage and electronic transactions. As domestic transaction costs decrease, and if there is an increased push from central banks or other regulators for more electronic transactions, then more consumers and retailers could well begin to shift payments from cash to cards.
While cost of cards is not the only reason for the continuing use of cash, of course, lower costs and an increasing push from financial as well as government institutions could hasten the shift.
The development of CUP actually dates back to the early 1990s, when China initiated the Golden Card project to improve card switching, interoperability and issuance. CUP was formally set up in 2002, with the backing of the People’s Bank of China and the State Council, and it now operates the system to connect banks and switch transactions domestically.
CUP has become a key part of China’s bankcard industry. As essentially the national bankcard association in China, CUP operates an interbank settlement system that connects and switches transactions between banks.
CUP says it “actively collaborates with various industrial parties like commercial banks in the efforts to formulate and extend united CUP card standards and regulations, create an independent bankcard brand, promote the development and application of bankcards, maintain an orderly bankcard acceptance market and prevent bankcard risks”.
With this infrastructure in place, the percentage of retail payments in China that are electronic rather than cash has risen significantly.
While other markets may not follow CUP into international markets, CUP started its internationalisation in 2004 when its cards began to be accepted in Hong Kong. Today, CUP cards are accepted in over 90 countries and financial institutions in nearly a dozen countries issue CUP cards.
In its Payment Systems in India Vision 2005-2008, published in 2005, the Reserve Bank of India laid out its plan for an ‘Indian retail clearing system’ that could handle “ATM-switching, multi-application smart card, e-commerce and m-commerce based payment systems”.
It proposed a national institution to “own and operate all retail payment systems of the country”.
Discussions by the Indian Banks Association (IBA) ensued and, by early 2008, the Rupee Times in India reported: “India Pay is expected to replace the existing payment networks for domestic transactions.”
A key reason was that “the fees charged by Visa and MasterCard are relatively high and when replaced by indigenous payment system IndiaPay, this fee is expected to reduce drastically”.
The National Payments Corporation of India (NPCI), set up in late 2008, noted RBI’s vision to “consolidate and integrate the multiple systems with varying service levels into nation-wide uniform and standard business process for all retail payment systems”.
IBA deputy chief executive K Unnikrishnan told the Business Standard newspaper that NPCI would focus on electronics payments, ATM transactions and processing of card payments.
The going has apparently not been easy. Sources at NPCI told India’s Moneylife early in 2010 that “as per the plan, our focus at the moment is on ATM switches, then we will launch the cheque-truncation system at Chennai followed by a unique identification-based financial inclusion payments and UA-switching or point-of-sales switching.
“The IndiaPay card is not [forthcoming] for the next three years.”
While it may take some time, domestic switching of transactions and the resultant reduction of $100m in costs is still in the works.
Discussions to set up a domestic clearing switch have been underway for at least half a dozen years and they are on “Round 4” according to industry observers, though anything from a lack of preparedness to differing agendas slowed progress.
Recently, however, the Malaysian Electronic Payment System (MEPS) has revisited the concept and appears to be moving forward. MEPS has reportedly met with financial institutions as well as the central bank, and one banker said it is “working towards 2011” in its development of a domestic clearing system along an aggressive timeline. Fraud monitoring and chargebacks might also be centralised under the new system.
While one goal is to reduce overall costs, one banker said he is worried “MasterCard and Visa will raise brand service fees” if switching fees drop.
Since Bank Negara Malaysia (BNM) is involved and the domestic clearing initiative may be regarded as a national agenda, he said, legislation or BNM regulations could still limit such rises if the card schemes do actually consider making changes.
While consideration of domestic processing started nearly a decade ago, the concept really took off in 2005 when ITMX said it would expand the company’s business scope relating to the Bank of Thailand (BOT) Strategic Payment Roadmap.
Following directions from the payment systems committee at BOT, ITMX was planned as the “key inter-bank payment infrastructure and central data processing system that exchanges, manages, and processes data across member banks/organisations in order to support e-payment, electronic fund transfer”.
In 2007, eFunds Corporation, working with IBM and Infomax, announced a contract with ITMX to automate “transaction processing across Thailand’s banking system”. The network, it said, was “set to manage over 1.5m transactions per day and is projected to grow 15% annually”.
Also in 2007, BOT’s Payment Systems Roadmap 2010 reinforced this direction as BOT said it would “conduct feasibility studies on local switching of domestic credit card/debit card and electronic money services to reduce operation costs for payment providers and stores”.
Discussions moved towards reality in late 2009 when the Local Switching Service Project was initiated by banks and ITMX, with guidance from BOT. In early 2010, ITMX released technical specifications for the project which, it said, is designed to “route and switch purchase transactions between the member banks”.
The specifications indicate the project would start with ATM card purchase transactions, then extend to card scheme debit cards and finally include card scheme credit card processing in a third phase.
While the timing for implementation is uncertain, Thailand too is moving towards a national switch.
Financial institutions and retailers in Australia have primarily used a combination of bilateral processing agreements and card scheme processing for clearing transactions. There is currently no multilateral processing network.
The two largest retailers, Coles and Woolworths, have sent transactions directly to card issuers and that practice may be expanding.
According to local reports: “Woolworths stands to save millions by diverting debit card payments away from global credit card networks MasterCard and Visa and channelling them through the Australian-owned EFTPOS network.”
A significant recent shift has been the emergence of EPAL, which was launched in 2009 to manage the proprietary debit network (EFTPOS) and expand its functionality to compete with scheme debit on a number of fronts. Furthermore, the Reserve Bank of Australia decided in November 2009 that the multilateral interchange fee for EFTPOS transactions should be allowed change from its current level of -A$0.05 (-$0.04)level up to A$0.12 so that it equals the current card scheme debit interchange fees.
With a company in place and a shift in fees that could make domestic debit more financially competitive, one banker said the next step could well be “to look at building a centralised infrastructure for switching multilateral transactions.”
While work on this infrastructure has not started yet, EPAL could soon start building its own switching capability for its fourteen member institutions and offer enhanced services such as EMV, contactless, mobile and internet payments.
The net result of these developments is the potential for significant changes in the bankcard industry in Asia-Pacific over the next three to five years. China UnionPay is expanding, and India, Malaysia and Thailand all look set to implement domestic switching soon. Australia has the potential to move along the same path.
While other markets such as Indonesia or Singapore do not seem to have started talking concretely about similar developments, they too could move in a similar direction. The net effect could be more transactions flowing across domestic clearing systems and a significant decline in transactions switched by the card schemes, as well as a drop in card scheme revenue from domestic processing.
Whether the card schemes can or will respond by attempting to increase brand assessments or other fees to make up for declining domestic switching revenue remains to be seen.
How central banks or national legislatures respond to any such developments will also only play out over time.
While the exact details and timing of the transitions remain to be seen, it is certain that fundamental changes in the cards industry are underway.