Interchange reform needed to corral companion cards

Visa commissioned Deloitte to report on developments in card payments since 2003, when the RBA regulated the interchange fees charged by four-party scheme credit and debit cards operated by MasterCard and Visa.

Deloitte has backed Visa's call for reform of the Payments System (Regulation) Act to create competitive neutrality. It said either interchange regulation should be removed or all schemes should be regulated in a comparable manner.

The RBA decision not to regulate the internal transfers embedded in the three-party card schemes operated by American Express and Diners Club has been a sore point with Visa and MasterCard ever since 2003.

According to Deloitte, the RBA made the decision because the lack of an explicit fee meant that any regulatory solution would be more complex than the interchange regulation it imposed on the four-party schemes.

Three-party schemes have tended to charge significantly higher merchant service fees than four-party schemes. These fees fund generous reward schemes.

At the time of the 2003 reforms, merchant service fees in the three-party schemes were around 1.8 times those in four-party schemes. This ratio jumped as the regulations constrained the fees charged by the regulated schemes.

By 2008 the merchant service fees in the unregulated three-party schemes were around 2.7 times higher than those in the four-party schemes. The ratio has remained at this level for Diners Club but has fallen to 2.3 times for American Express.

The value of rewards for four-party schemes have declined by around one-third, while the value of rewards offered on companion cards are around 1.5 to two times greater than Visa and MasterCard.

Deloitte said: "The RBA hoped that allowing surcharging would place sufficient downward pressure on three-party scheme fees. As it has turned out, this expectation has not materialised. The gap between the different types of scheme fees has widened.

"Of particular significance has been the entry into the market of offerings that amount to new four-party card schemes."

Deloitte said traditional three-party schemes had developed ways to take advantage of their unregulated position.

The most prominent has been the American Express four-party companion credit card.

These cards operate according to a four-party model (the payments company plays the role of acquirer on transactions but cards are issued by the cardholder's bank) but they have escaped interchange regulations.

"Three-party schemes have increased their share since the introduction of the interchange rules. Ordinarily such competition would be welcome but when it is, in part, the result of uneven regulatory treatment it is likely to result in an inefficient distortion of market structure," Deloitte said.