Following the EC’s ruling on cross-border interchange fees, the
implications for both Visa and MasterCard could be far-reaching,
although industry analysts differ in their views on how this may
affect the payment industry as a whole. William Cain

Retailers have claimed victory following the European
Commission’s decision to make cross-border interchange fees
illegal, while MasterCard has been left nursing its wounds. But
industry analysts have remained relatively sanguine regarding the
implications of the ruling, at least in the short term, mainly
because the outcome of the MasterCard decision had been so widely

Analysts at investment bank and securities broker Keefe,
Bruyette & Woods (KBW) described the ruling as “negative” but
altered their earnings expectations for MasterCard only minimally
when the news broke. KBW’s research note said: “While the news flow
surrounding the European Commission’s decision could pose headline
risk for shares of MasterCard, we believe it does not materially
affect the company’s business model.”

KBW said it believes the company can hold its line on revenue
margins from current levels, and admitted it had been too
conservative on its expectations in this area before. KBW added the
company’s general and administrative account “should moderate in
2008 and 2009, relative to 2007, when the company spent heavily on
growing out personnel”.

Global investment bank Credit Suisse First Boston published its
research note on the interchange ruling before the official
announcement. The outcome was so closely aligned with its
expectations that it did not produce an update. The research note
said: “MasterCard expected such a decision by year-end. While the
European Commission has already informed MasterCard that it does
not intend to impose a fine, MasterCard will likely be ordered to
change the manner in which it calculates (or stop collecting)
cross-border default interchange fees. This could also result in
private lawsuits against MasterCard Europe by merchants or

Credit Suisse added that the regulatory pressures are likely to
create lower interchange rates for credit and debit transactions
over the next year. It would mean financial institutions lowering
revenue streams for payment processors, Credit Suisse said.

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The main concerns do not lie in the short term, but in the
potential domino effect the European Commission’s Competition
Commission ruling could have on domestic governments in Europe and
the rest of the world. Regulators have been closely following the
EC’s decision, and there is the possibility it will lead to a wider
crackdown on interchange fees, as has been seen in Australia. That
would hit the card associations such as MasterCard and Visa far
harder than the EC’s ruling on cross-border interchange fees.

Uncertainty in the longer term

In an interview, CI asked Francesco Burelli, a cards expert at
payment consultancy AT Kearney, for his opinion on this landmark

CI: What are the main implications for

FB: “MasterCard will have to appeal against the EC ruling and
sustain its case and defend its cross-border multilateral
interchange fee [MIF] against the accusations of violating EC
Treaty rules on restrictive business practices. If the case is
lost, the implications are far-reaching. First of all, it would
galvanise domestic regulators to follow suit and intensify
investigations on domestic interchange and mirror the initiative of
the European Commission.

“MasterCard has so far benefited from a higher interchange level
than other domestic and international schemes by offering a more
appealing business case to member banks. Any reduction to its
interchange rates would result in MasterCard not just losing part
of its competitive advantage over other schemes, but losing one of
the main cogs that enable a four-party payment scheme to operate
efficiently. Should the case for cross-border interchange fail, the
very existence of domestic interchange would become questionable –
this would challenge the existence of four-party card payments
schemes as we know them. Interchange is a vital part of a
four-party card payment network and it equalises a cost imbalance
between the issuing and the acquiring side of the business.

“Should interchange disappear, the question would be about what
fair mechanism can be adopted by MasterCard to replace interchange
other than leaving banks on their own to try to replace an
important revenue source.”

CI: What are the main implications for Visa?

FB: “In 2002 the commission exempted Visa’s MIF in the European
Union for a period of five years, subject to accepting a reduction
of its MIF and other terms of the exemption. The exemption came to
an end on 31 December 2007. The EC ruling on MasterCard’s cross
border interchange rate provides Visa with a warning of what it may
expect once the exemption is expired and the scheme may be subject
to similar treatment from the regulator.

“This is also a warning for Visa and other schemes about the
dangers of the potential effects of increasing interchange fees, as
these will only attract more attention from regulators and increase
the pressure that the merchant lobbies are putting on media and

CI: Who benefits most from this – consumers, retailers or

FB: “Based on what happened in the previous cases of interchanges
being reduced by regulatory intervention, the only beneficiaries of
this ruling are the merchants. Whilst the value of cross-border
purchases is negligible compared to the value of domestic business
and hence the economic benefit is not significant, this is a
significant victory for the merchant associations and lobbies
against the card payment schemes that will certainly lead to more
attacks on interchange and charges levied onto merchants for
plastic card payment acceptance.

“It should not be forgotten that merchants, especially the
smaller ones (the vast majority of European retailers fall in this
category), have been resisting plastic payments on the basis that
they are perceived to be not only more expensive than cash
acceptance, but also that it is impossible to hide revenue paid by
plastic from the taxman. The elimination of interchange will
certainly result in higher costs for consumers who will be
penalised for holding cards in their wallets and paying by plastic,
and cash payments could potentially enable some merchants to hide
more revenues from their tax files.

“Cross-border card payments are a small percentage, between 1
and 2 percent, of total cards transactions, so the economic loss of
cross-border interchange should not have a significant impact for
issuers. In any case, banks will lose a source of revenue that is
compensating for higher issuing costs compared to acquiring and for
services provided to the merchants by the provision of card payment
services. As has happened in other cases – eg, Australia – it is
expected that banks will end up compensating for the loss of
revenue by increasing annual card fees, applying card usage fees
and curbing additional services and benefits that have been so-far
associated to cards.

“Despite all the claims of the merchant community, consumers
will be the only losing party. It is yet to be proven that any
savings derived by the reduction or scrapping of the interchange
fee by merchants will be transferred to consumers by a reduction of
retail prices. This has not been the case in any of the previous
instances of regulatory intervention on interchange, despite the
claims of the propaganda machine of the merchant community.
Consumers will end up paying more for providing merchants with the
added benefit of cards payment.”

CI: Is it fair to say this is a bungled attempt by the
European Commission to benefit the consumer

FB: “Yes, I would question the rationale on which this decision has
been taken. Given the radical ruling of the regulator, it would
appear that the EC is not taking into account the principles on
which a four-party system works. I think that as it stands it
threatens the viability of the card payments schemes as we know
them and will not encourage issuing efforts aimed at replacing
cash. I would also point out that, given the goal of consistent
pricing of cross-border payments within the context of SEPA, the EC
has scrapped one of the few consistent payment fees that were in
use across the euro countries so far.”

CI: One key part of the decision hinged around Australia’s
decision to reduce interchange fees. The EC says Australia’s cards
industry benefited from a reduction in interchange fees, MasterCard
says the policy meant card fees went up – who is

FB: “As history proves, MasterCard is right and evidence denies
that the Reserve Bank of Australia decision has brought any sort of
benefit to consumers. In Australia, consumers have been hit by the
decision, while merchants have reaped the whole benefits. Instead
of retail prices coming down, as claimed by the merchant
propaganda, Australian consumers ended up being much worse off as
it cost them more to hold a card in their wallet. Most card-related
benefits (eg, insurance) were lost, and surcharges were levied by
merchants for payments with cards instead of cash.”

CI: As we saw in Australia, are we more likely to see an
increase in debit card use?

FB: “Debit card usage would keep growing in the majority of
countries worldwide regardless of the EC ruling. It is very likely
that we will see banks moving transactors off to three-party
schemes (that are even less welcomed by merchants in view of the
higher fees applied to acceptance). We will also see card annual
and usage fees raise, and card benefits reduced. In case of
reduction or scrapping of cross-border and domestic interchange
fees, I would expect Amex card issuance rates to increase.”

CI: Could we actually see a reduction in card options and
an increase in fees – in effect, reducing competition in the cards
industry, rather than promoting it?

FB: “This would be a certain consequence as issuers and schemes
would have to be more focused on compensating for losses and
managing products that are in many instances generating losses,
rather than be focused on innovation that would not just make the
card payment industry more efficient and offer more choice to
consumers, but also encourage a higher degree of adoption of cards
as a preferred method of payments in lieu of cash and cheques. All
in all, the abolition of interchange would not just limit
competition within the cards industry, but also impact negatively
the migration to electronic payments from cash and cheques.”

CI: Does this decision appear to have been rushed through
to prevent a possible collapse of the third debit scheme, as well
as the effectiveness of the SEPA initiative?

FB: “There is no doubt that the EU is not looking favourably at the
growing adoption of Maestro and V PAY as preferred debit cards as a
way to comply with SEPA, and the EC ruling is damaging MasterCard
while it does not affect the domestic debit schemes. By now it is
obvious that it has not been possible to identify a financially
viable solution to SEPA by means of a third scheme and that the
multiple bilateral option proposed by the European Alliance is not
workable yet.

“With SEPA now a reality, the only viable option available to
banks for debit card compliance appears to be presented by the
international debit schemes. Market rumours are indicating that an
increasing number of European banks are in discussion or close to
the decision to migrate their debit card portfolios either to
Maestro or V PAY. Attacking the more favourable economics of
international debit schemes over the rates applied by domestic
schemes may well be part of an attempt to discourage more banks
from scrapping their domestic debit card portfolios. If this is the
case, I would raise serious doubts about the effectiveness of the
move for two reasons.

“First, large banks with international presence may have an
interest in having a consolidated card portfolio across all of
their multiple domestic retail franchise. Currently no former
domestic card scheme is capable of operating cross-border unless by
co-branding with an international scheme. The financial benefits of
a consolidated, higher volume portfolio of cards would still be
significant compared to the implications of managing a number of
card portfolios on a domestic basis.

“Second, international scheme debit cards are still the closest
solution to debit card SEPA compliance.”

CI: This decision prohibits cross-border interchange fees –
is it likely national governments will now try to make all
interchange fees illegal?

FB: “Regulators and governments have a tendency to imitate each
other’s initiatives and decisions, so it would not be surprising to
see governments take a herd approach and move in direction similar
to that of the European Commission.”