Retail payment systems Issues Paper

Retail payment systems in

New Zealand

Issues Paper

October 2016

MINISTRY OF BUSINESS, INNOVATION & EMPLOYMENT

Retail Payment Systems in New Zealand: Issues Paper

Contents

Contents ........................................................................................................................................ 2

How to have your say .................................................................................................................... 3

Glossary of terms .......................................................................................................................... 5

Executive Summary ....................................................................................................................... 6

1. Introduction ........................................................................................................................ 11

Structure of this Issues Paper ...................................................................................... 11 1.1

What are retail payment systems? ............................................................................. 12 1.2

Objectives .................................................................................................................... 12 1.3

Regulation of retail payments in New Zealand ........................................................... 13 1.4

2. Payment systems in New Zealand ....................................................................................... 16

Introduction ................................................................................................................ 16 2.1

Parties in the system ................................................................................................... 17 2.2

Types of payment card and the types of transactions ................................................ 18 2.3

Methods of switching .................................................................................................. 20 2.4

Trends in usage of payment options ........................................................................... 21 2.5

Emerging payment methods ....................................................................................... 23 2.6

3. Market business models and resource costs ...................................................................... 27

Switch-to issuer transactions ...................................................................................... 27 3.1

Switch-to-acquirer transactions .................................................................................. 30 3.2

Ancillary relationships ................................................................................................. 44 3.3

Resource costs ............................................................................................................. 45 3.4

4. Issues identified................................................................................................................... 47

Overview ..................................................................................................................... 47 4.1

The interchange business model is resulting in inefficient outcomes in the credit card 4.2

market ..................................................................................................................................... 48

Inefficiencies could develop in the debit market ........................................................ 54 4.3

There is a large gap between the MSFs faced by small and large merchants ............ 62 4.4

Assessment against objectives .................................................................................... 64 4.5

5. Possible next steps .............................................................................................................. 65

Immediate actions ....................................................................................................... 65 5.1

Further work to address the wider policy issues ........................................................ 66 5.2

Recap of questions ...................................................................................................................... 69

Annex 1: International experiences ............................................................................................ 71

Annex 2: The Commerce Commission’s 2009 settlement .......................................................... 77

Annex 3: List of stakeholders ...................................................................................................... 79

Annex 4: Key figures used in this Issues Paper ........................................................................... 80

MINISTRY OF BUSINESS, INNOVATION & EMPLOYMENT

Retail Payment Systems in New Zealand: Issues Paper

How to have your say

The Ministry of Business, Innovation and Employment (MBIE) seeks written submissions on the

issues raised in this document by 5pm on Tuesday, 13 December 2016. Questions are posed

throughout the document to guide your submission.

Your submission may respond to any or all of these questions. We also encourage your input

on any other relevant issues. Where possible, please include evidence to support your views,

for example references to independent research, facts and figures, or relevant examples.

You can make your submission:

• By sending your submission as a Microsoft Word document to

competition.policy@mbie.govt.nz

• By mailing your submission to:

Competition and Consumer Policy

Building, Resources and Markets

Ministry of Business, Innovation & Employment

PO Box 1473

Wellington 6140

New Zealand

Please direct any questions that you have in relation to the submissions process to Steven Sue

on steven.sue@mbie.govt.nz

Use of information

The information provided in submissions will be used to inform MBIE’s policy development

process, and will inform advice to Ministers on retail payment systems.

We may contact submitters directly if we require clarification of any matters in submissions.

Submissions are subject to the Official Information Act 1982. MBIE intends to upload PDF

copies of submissions received to MBIE’s website at www.mbie.govt.nz. MBIE will consider you

to have consented to uploading by making a submission, unless you clearly specify otherwise

in your submission.

Please set out clearly with your submission if you have any objection to the release of any

information in the submission, and in particular, which parts you consider should be withheld,

together with the reasons for withholding the information. MBIE will take such objections into

account and will consult with submitters when responding to requests under the Official

Information Act 1982.

If your submission contains any confidential information, please indicate this on the front of

the submission. Any confidential information should be clearly marked within the text. If you

wish to provide a submission containing confidential information, please provide a separate

version excluding the relevant information for publication on our website.

MINISTRY OF BUSINESS, INNOVATION & EMPLOYMENT

Retail Payment Systems in New Zealand: Issues Paper

Private information

The Privacy Act 1993 establishes certain principles with respect to the collection, use and

disclosure of information about individuals by various agencies, including MBIE. Any personal

information you supply to MBIE in the course of making a submission will only be used for the

purpose of assisting in the development of policy advice in relation to this review. Please

clearly indicate in your submission if you do not wish your name to be included in any

summary of submissions that MBIE may publish.

Permission to reproduce

The copyright owner authorises reproduction of this work, in whole or in part, as long as no

charge is being made for the supply of copies, and the integrity and attribution of the work as

a publication of MBIE is not interfered with in any way.

ISBN 978-0-947524-29-6 (online)

MINISTRY OF BUSINESS, INNOVATION & EMPLOYMENT

Retail Payment Systems in New Zealand: Issues Paper

Glossary of terms

Acquirer: An organisation, typically a bank, which provides access to the payment system on behalf of

merchants for the clearing and settlement of funds in a transaction. An acquirer may or may not also be the

bank that provides other services to a merchant, such as lending and deposits.

Cardholder/customer/consumer: Buys goods and services from merchants in exchange for payment.

Card-present transaction: Any transaction where a customer is in the same physical location as the merchant.

Card-not-present transaction: Any transaction made online, over the phone, or in other situations in which a

customer is not in the same physical location as the merchant.

Contactless transaction: Any transaction made using contactless technology (such as Visa PayWave and

MasterCard PayPass) where the customer is in the same physical location as the merchant. Includes card- and

app-based payments.

Customer interface: Either the physical terminal (card-present) or digital customer gateway (card-not-present)

through which the customer makes a payment to a merchant.

Direct entry: A method of transferring funds between bank accounts that does not rely on scheme or

proprietary EFTPOS rails. Also known as account-to-account payments. Can include manual bank transfers,

automatic payments, direct debit transactions, etc.

Interchange fee: A payment made from an acquirer to an issuer (or occasionally the reverse), each time certain

forms of retail payments are made.

Issuer: An organisation, typically a bank, which issues cards and provides debit and/or credit services to

customers.

Merchant: A party that provides goods or services in return for payment. Includes retailers, wholesalers,

utilities companies, and central and local government.

Merchant service fee (MSF): A payment made from a merchant to an acquirer each time certain forms of retail

payments are made.

Proprietary EFTPOS: The ‘traditional’ form of card payment in New Zealand, which utilises mag-stripe

technology. Standards are maintained by Payments New Zealand, but no ‘owner’ as such.

Resource cost: The economic resources expended by system participants to ‘produce’ a payment. This includes

fraud prevention costs, authorisation and transaction processing costs, and other back-office costs. Excludes

transfers between parties, such as rewards or MSFs.

Scheme: Includes Visa, MasterCard, American Express, and Diners Club. Schemes develop technology and base

product features, and set the commercial model and card system rules. They may issue cards and attract

merchants through banks (open system – Visa and MasterCard) or directly (closed system – American Express,

Diners Club, etc.). Only relevant for non-proprietary-EFTPOS transactions.

Steering: When a merchant does not accept, or discourages, payment via certain means.

Surcharging: When a merchant charges more to accept payment via certain means.

Switch: Payments infrastructure that sends transaction information to the correct issuer or acquirer

(depending on the type of transaction) so that the funds can be taken from the customer's account and

delivered to the merchant.

Switch-to-acquirer: The process by which information about certain card payments, notably credit cards,

contactless scheme debit, card-not present and international transactions, is sent between institutions.

Attracts interchange (except for closed schemes) and MSFs.

Switch-to-issuer: The process by which information about certain card payments, notably proprietary EFTPOS

and inserted/swiped scheme debit, is sent between institutions. Attracts no interchange fee or MSF.

MINISTRY OF BUSINESS, INNOVATION & EMPLOYMENT

Retail Payment Systems in New Zealand: Issues Paper

Executive Summary

Overview

1. In February 2016, the Minister of Finance and the Minister of Commerce and Consumer

Affairs commissioned a study into New Zealand’s retail payment system in the context

of:

• merchant concerns about increasing fees for the processing of electronic

transactions;

• industry developments, including the adoption of new technologies; and

• ongoing reforms to the oversight and regulation of retail payment systems in

overseas jurisdictions.

2. In addition to outlining how retail payment systems work in New Zealand, this Issues

Paper looks at the economic outcomes that result from New Zealand’s retail payment

system (as opposed to, for example, financial system stability outcomes which are

considered by the Reserve Bank). It focuses predominantly, but not exclusively, on credit

and debit cards, in reflection of their dominance of retail payments.

3. This Issues Paper was developed by the Ministry of Business, Innovation and

Employment so the views expressed in this paper should be read as the Ministry’s

preliminary views, not necessarily those of the Government.

4. The Government is now wishing to test the Ministry’s analysis with the public. Retail

payment systems are extremely complex and it is important to fully understand the

issues before the Government decides whether to proceed any further. While the

Government is not at the stage of considering options, it is also important to bear in

mind that if we proceed to that stage, any potential solution would need to be tested

against the harm it is designed to address and that all the consequences are taken into

account.

5. For example, some overseas jurisdictions have regulated interchange fees to address the

issues discussed in this Issues Paper. While this approach is designed to address the

issues at hand by reducing the ability of banks to provide generous rewards to

incentivise credit card use, it could also see banks increase annual fees on credit cards to

maintain reward levels, or reduce the generosity of reward programmes. It is therefore

important to understand all of these impacts when considering the issues.

Background

6. Each year consumers make approximately 1.5 billion electronic card transactions,

representing more than $76 billion in expenditure. Transactions made using electronic

cards are responsible for around two thirds of retail trade revenue in core industries,

and this share of retail revenue has been growing steadily compared to other payment

methods such as cash. Within card-based payments, currently around 42 per cent of

transactions (by value) are made using credit cards, 36 per cent using proprietary

EFTPOS, 15 per cent using swiped/inserted scheme debit, and 7 per cent using

contactless scheme debit. While cash remains an important retail currency, New

Zealand has the lowest proportion of cash to GDP in circulation in the world. The

MINISTRY OF BUSINESS, INNOVATION & EMPLOYMENT

Retail Payment Systems in New Zealand: Issues Paper

payment card market can be considered to be at saturation, with 93.8 per cent of adults

in possession of and using a debit card.

7. Electronic payments provide a number of key benefits to consumers, merchants (such as

retailers), and government. This includes greater convenience; reduced risk of fraud,

theft, and bad debts; the ability to purchase online; reduced cash-handling costs; greater

certainty of tax revenue; and – in the case of credit cards – the ability to smooth

consumption over time.

8. We estimate that the inherent ‘resource cost’ of processing card payments each year is

around $950 million, or roughly 1.3 per cent of the value of the $76 billion dollars of

transactions made on payment cards across the economy. This is the economic resource

required to facilitate these transactions. Merchants carry the bulk of the direct costs,

paying an estimated $461 million in merchant service fees in 2015. We expect that these

fees could increase significantly in coming years with rapid uptake of contactless

payment. This could increase the fees paid by another $216 million annually.

9. In preparing this Paper, we asked the following questions:

• Are consumers and merchants benefiting from ongoing innovation?

• Are card payment systems being used efficiently?

• Are consumers and merchants bearing a fair share of the costs?

Issues identified

10. The Ministry has found that the market dynamics suggest cause for concern in both the

credit and debit card markets.

Issue 1: Economic inefficiency in the credit card market

11. We consider that there is economic inefficiency in the credit card market. While credit

cards provide a number of benefits to both consumers and merchants, we estimate that

current market incentives drive at least $45 million per year of additional cost to the

economy through the use of more expensive credit card networks compared to lower

cost EFTPOS networks. This figure focuses on the transactions that are induced by the

incentives in the system, not the ones that are placed on credit cards on the basis of

their inherent credit functionality or their ability to be used overseas. $45 million

represents 5 percent of the total resource cost for processing electronic card payments

in New Zealand, and around 0.13 per cent of the total value of expenditure on credit

cards in the year to March 2016.

Issue 2: Increased prices for all consumers, with only higher-income consumers

benefiting from rewards

12. The costs of merchant service fees are ultimately likely to be passed onto consumers

through the price of goods and services. Some of the cost that is passed on is used to

fund rewards and other inducements for using credit cards. We estimate that merchants

have to increase their prices to all consumers by around $187 million per year to fund

rewards paid to certain credit card users. Because of the way credit card reward

schemes are structured, this leads to an annual regressive cross-subsidy of $59 million

from low-income to high-income households. These costs are ongoing, so they add up

over many years.

13. Issues 1 and 2 are a result of the business model under which credit card schemes

operate. Payment systems are two-sided markets, in that they rely on uptake by both

MINISTRY OF BUSINESS, INNOVATION & EMPLOYMENT

Retail Payment Systems in New Zealand: Issues Paper

consumers and merchants to be valuable. At the centre of this business model is the use

of interchange fees, which place charges on merchants and pass them on to the banks

that issue credit cards. Interchange fees allow banks that issue credit cards to incentivise

credit card use, such as through rewards schemes, effectively paying many consumers to

use their credit card instead of the cheaper EFTPOS system. These interchange fees are

then passed onto all consumers (irrespective of the type of card used) through higher

prices because most merchants do not recover those fees through surcharges.

14. Credit card schemes have traditionally operated under this interchange business model,

but there is evidence that the inefficiencies generated are increasing, with recent

competition driving up interchange fees and the value of rewards. We are also seeing

banks “flipping” credit card users to higher cost premium cards that offer higher levels

of rewards. All but the largest merchants hold little bargaining power over these fees,

with consumer demand giving them little choice but to accept payment via credit card.

15. These outcomes are not the result of irrational or anti-competitive behaviour by any

particular party. It is completely rational for credit card holders to maximise usage to

obtain rewards in the presence of distorted price signals. Similarly, the setting of

interchange and use of rewards schemes is perfectly rational profit maximising

behaviour on the part of the schemes and the banks. Despite this individual rationality,

without price signals, this business model results in an inefficient overall outcome.

16. Based on the information available to us, merchants in New Zealand appear to pay

higher fees to accept payment via credit card than merchants in some overseas

countries. New Zealand’s credit interchange fees are roughly comparable to what is paid

in the USA and Canada, where credit interchange is not regulated. However, New

Zealand interchange rates and merchant service fees are significantly higher than those

in regulated environments, such as the European Union and Australia. The overall higher

cost of electronic transactions may be offset to some extent because no charges are

applied to EFTPOS and swiped/inserted scheme debit transactions, which currently

account for around half of all card transactions.

Issue 3: Emerging inefficiency in the debit card market

17. Similar market dynamics are beginning to emerge in the debit card space, with rapid

growth of the market share of scheme debit products in place of New Zealand’s

proprietary EFTPOS system. Contactless and online scheme debit now make up about 15

per cent of the debit card market, up from about two per cent two years ago. New

Zealand is different to many economies in still having a domestic EFTPOS system that

does not charge per-transaction fees to merchants. It is, however, unlikely that such a

model is sustainable when competing with scheme products, regardless of the

underlying efficiency of domestic EFTPOS.

18. The growth of scheme debit products provides many benefits – such as additional

security, and the ability to make contactless and online transactions – in contrast to

proprietary EFTPOS which has suffered from a sustained lack of investment.

19. Nevertheless, such benefits come with additional cost, as schemes have introduced

interchange fees on contactless (and online) debit transactions, in contrast to

proprietary EFTPOS, which does not attract such fees. We estimate that fees to

merchants on scheme debit transactions could rise by $216 million per year if

contactless usage increases to 60 per cent of debit payments.

20. The imposition of fees in itself is not inherently a problem, given that the lack of fees is a

key reason behind the lack of investment in proprietary EFTPOS. However, as

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Retail Payment Systems in New Zealand: Issues Paper

contactless debit becomes entrenched, we are concerned that the competitive

constraint on fees to merchants currently provided by proprietary EFTPOS will reduce.

This could result in the interchange dynamics we currently see in the credit card market

driving inefficiency and large scale cross-subsidisation in the debit market as well.

Issue 4: Barriers to entry in the debit market

21. We are also concerned about the impact that a scheme-dominated debit market would

have on market entry and expansion. While it is possible for a new entrant to disrupt the

market before full scheme dominance occurs, the interchange model sets up entry and

expansion barriers by giving card issuers (banks) significant financial incentives to favour

payment systems that offer interchange income. Potential new payment options would

likely need to compete on an interchange-like system (bidding up prices and distorting

price signals) in addition to providing improved functionality, if they are to be attractive

to consumers and banks.

Issue 5: Impact on small business

22. In addition to the inefficiency that the scheme interchange model is driving, there

appears to be systemically higher costs placed on smaller merchants to pay for the

processing of retail transactions. The interchange charged for small merchants can in

some cases be two and a half times the interchange rates for the largest, ‘strategic’

merchants. While there is likely to be some cost differential underlying the gap between

fees charged to large and small merchants, a closer look at the marginal costs involved

in processing transactions suggests that differences in underlying system costs are

unlikely to be a dominant driver of the growing differential in merchant service fees

between small and large merchants. If the spread were to increase further, we are

concerned that the disadvantage faced by smaller merchants could ultimately harm

retail competition.

Next steps

23. The Ministry of Business, Innovation and Employment considers that the nature and the

scale of the issues identified in the credit market, and the potential for these issues to

develop in the debit market, warrant additional work to address these issues. Similar

issues have been identified around the world, and it is only in countries where some sort

of regulatory intervention has occurred that these impacts have been addressed.

24. The Government is now testing the Ministry’s analysis and proposed next steps before

any decision is made about whether to progress this work further. Questions have been

posed throughout this paper for your consideration.

25. If the Government does choose to progress this work further, the complexity of the

retail payment system and the potential pace of change means that it will be important

for the following to be taken into account when developing a way forward:

• the New Zealand context;

• the effectiveness and net benefits of each option;

• any consequential impacts on consumers and merchants, investment in innovation,

and development of the broader retail payments sector; and

• the timeliness of any intervention.

MINISTRY OF BUSINESS, INNOVATION & EMPLOYMENT

Retail Payment Systems in New Zealand: Issues Paper

26. Should further work be undertaken, it would involve close engagement with

stakeholders, in order to ensure that any proposals make the best use of industry

expertise and take into account any stakeholder concerns.

27. The Ministry considers that further investigation would be worthwhile on the following:

• The costs and benefits of applying interchange regulation to the credit market (and

the under which it would be applied in the debit market).

• Whether there are economic, institutional and technical barriers to entry and

expansion for new payment methods in the debit market, and options for addressing

any such barriers.

• Examination of other options, including: whether the governance of payment

systems can be improved; whether lighter-touch regulation, such as an industry code

of conduct, would have merit; whether EFTPOS could be made a sustainable

alternative to scheme debit products; and whether the retail payment system, or a

part of the system, should be treated like a utility.

MINISTRY OF BUSINESS, INNOVATION & EMPLOYMENT

Retail Payment Systems in New Zealand: Issues Paper

1. Introduction

28. In February 2016, the Minister of Finance, the Hon Bill English; and the Minister of

Commerce and Consumer Affairs, the Hon Paul Goldsmith, asked officials to undertake a

study into retail payment systems in New Zealand. The objective of the study was to test

whether the system – in its current state, and as it is likely to develop in the future – is

delivering good outcomes for consumers and merchants and the New Zealand economy

as a whole.

29. The decision to undertake a study into retail payments was triggered by a number of

factors, including:

• merchant concerns about increasing fees for the processing of electronic

transactions;

• industry developments, including the adoption of new technologies; and

• ongoing reforms to the oversight and regulation of retail payment systems in

overseas jurisdictions.

30. Officials from the Ministry of Business, Innovation and Employment (MBIE) provided the

Government with a report in July 2016. It was developed in consultation with around 30

industry participants, including Retail New Zealand; small and large retailers; all major

banks, credit card schemes and ‘switches’; Consumer New Zealand; market challengers;

and independent experts. Some stakeholders provided us with non-public data to

support us to draw conclusions. While we have included as much information as

possible in this document, we have not published commercially sensitive information.

31. The report was independently reviewed by Dominic White of Pebble Payments and Mike

Laing of LWT Advisers. Both are payment systems specialists based in Australia.

32. The Government is now seeking feedback from stakeholders and the wider public on the

issues and proposed next steps outlined in this report. Questions have been posed

throughout this paper for your consideration.

Structure of this Issues Paper 1.1

33. The remainder of the Introduction sets the scene for the analysis that follows, by

defining the scope of the issues addressed in this Issues Paper, proposing public policy

objectives for retail payment systems, and outlining how retail payment systems are

currently regulated in New Zealand.

34. Section 2 outlines how retail payment systems work – the main participants in the

system, the mechanics of how payments are processed, and trends in how different

retail payment options are being used.

35. Section 3 looks at the business models underpinning retail payment options, how costs

and charges flow through the system, and the incentives that result. This section also

considers the relative resource cost of putting payments through the various payment

channels.

36. Section 4 presents the issues we have identified with retail payment systems, as they

currently operate. This section looks at whether the market set up is achieving the sorts

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Retail Payment Systems in New Zealand: Issues Paper

of economic outcomes that are desirable, and whether this is likely to be the case as the

market evolves.

37. The final section outlines our preliminary thinking about next steps to address these

issues.

What are retail payment systems? 1.2

38. A payment system can be defined as the arrangements that allow consumers,

businesses and other organisations to transfer funds usually held in an account at one

financial institution to another. It includes the payment instruments – cash, cheques and

electronic funds transfers which consumers use to make payments – and the usually

unseen arrangements that ensure that funds move from accounts at one financial

institution to another.

39. There are various layers to a payment system:

• the underlying network or “rails”, each with its own technical and operational

standards – such as the Visa or MasterCard card networks, the Electronic Funds

Transfer at Point of Sale (EFTPOS) system, ‘direct entry’ into a bank account, or cash;

• the product or method of payment that sits on these rails – such as automatic

payments, direct debits, bank transfers, credit cards, online banking and mobile apps,

scheme debit cards, and proprietary EFTPOS cards; and

• the initiator of the transaction – i.e. consumer, business, or government.

40. This study considers retail payment systems, which we take to mean a system that is

used to clear (the transmission of information through the system to authenticate

identities and the availability of funds) and settle (the actual transfer of funds between

accounts) financial transactions between consumers and merchants

in return for goods

and services. Retail payment systems are distinguished from large-value payment

systems, which largely involve transactions made between financial institutions.

41. This study focuses particularly, but not exclusively, on card networks (Visa and

MasterCard) and the EFTPOS system, although other underlying networks and products

– including potential emerging disruptors – are considered throughout this report as

comparisons. While our focus is primarily on transactions made by consumers, many of

the issues discussed will nevertheless apply to business-to-business transactions.

42. Retail payment systems involve network effects, in that the value of the payment

system as a whole rises as more people use it. In particular, retail payment systems are a

form of two-sided market. Essentially, this means that for a given system to be

successful, it must attract both consumers and merchants to use its system. No

consumer will use a payment method if it is not accepted by a merchant, and no

merchant will accept a payment method that is not used by any consumer.

Objectives 1.3

43. This study is focussed on the economic outcomes delivered by retail payment systems in

New Zealand. This is complementary to the objectives held by other regulatory bodies in

New Zealand. For example, it is vital that payment systems are safe, secure and subject

Reserve Bank of Australia. (n.d.). Payments System. Retrieved from http://www.rba.gov.au/payments-

and-infrastructure/payments-system.html.

We use this term in a relatively wide sense in this Issues Paper to include payments made by

consumers to retailers, wholesalers, utilities companies, and central and local government.

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Retail Payment Systems in New Zealand: Issues Paper

to prudential supervision. However, we do not focus on these objectives here, as the

Reserve Bank largely holds responsibility for these outcomes in its prudential role.

44. In considering whether good economic outcomes are being delivered, we have used the

following objectives to assess New Zealand’s retail payment systems:

• Objective One: There is innovation and development of payment options that are

valued by consumers and businesses.

• Objective Two: Resources are allocated efficiently at a system level. In the context of

retail payments, this means that the mix of transaction methods used represents the

underlying preferences of consumers and merchants, taking into account the

marginal benefits and costs of certain forms of payment to the system as a whole.

• Objective Three: The cost associated with payment systems is distributed fairly

across consumers and merchants at an individual level.

45. These objectives – of innovation, efficiency, and fair distribution of cost – are tied to the

Government’s priority of building a more productive and competitive economy.

1 Are these objectives for retail payment systems appropriate?

46. We have not explicitly considered the competitiveness of the market. Competition can

take place within a payment system (such as between Visa and MasterCard), and

between payment systems (such as between credit cards and proprietary EFTPOS). In

terms of the former, as will be discussed throughout the Issues Paper, the two-sided

nature of retail payment systems means that it is possible for there to be competition

within a payment system, but for this to result in inefficient overall outcomes. In terms

of the latter, we see the outcomes (as captured by Objectives One to Three) as more

important than the input (i.e. the number of competing payment networks).

47. The ability to extract excessive profits is usually checked by competitive processes. We

have not examined profit levels, and whether these are ‘reasonable’, at any level of the

market. Such an exercise would be resource-intensive and difficult to undertake based

on publicly-available data. The analysis in this Issues Paper instead centres on the

economic incentives faced by market participants.

Regulation of retail payments in New Zealand 1.4

48. Retail payment systems are subject to relatively light-handed regulation in New Zealand.

Nevertheless, the following government and non-government regulatory bodies have

some form of oversight of their operation.

1.4.1 Prudential and system stability: Reserve Bank of New Zealand

49. Under the Reserve Bank Act 1989, the Reserve Bank has a mandate to promote the

maintenance of a sound and efficient financial system. In practice, the Reserve Bank has

not tended to treat efficiency as a standalone objective, but rather something that

should be pursued in conjunction with its soundness objective. Partly this is because a

focus on soundness is inherent in prudential regulation, and partly it is because

soundness and efficiency are mutually supporting concepts over the longer term.

50. In light of the fact that the Reserve Bank does not treat efficiency as a standalone

objective, it has minimised its role in respect of efficiency issues to a focus on access to,

and governance of, payment systems, minimising regulatory barriers to entry and

compliance costs, and effective market disclosure on soundness issues. As a result, the

performance and efficiency (allocative, dynamic, and productive) of retail payment

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Retail Payment Systems in New Zealand: Issues Paper

systems are not the primary focus of the Reserve Bank. This is in contrast to its

counterparts in countries such as Australia, which has a more direct ‘efficiency’ element

in their mandate. Since 2012, the Reserve Bank has been undertaking a review of its

oversight of financial market infrastructures (FMIs). That work is not designed to alter

the Reserve Bank’s approach to the retail payment systems we consider here.

1.4.2 Rules and standards for interoperability: Payments New Zealand

51. Payments New Zealand is the operator of a number of payment systems in New Zealand

(including the Consumer Electronic Clearing System, which includes proprietary EFTPOS).

It aims to promote “simple, innovative, and secure payment systems in New Zealand”.

Payments New Zealand was established in 2010 by eight banks (the shareholders) with a

mandate to open access to and preserve the integrity of New Zealand’s payment

systems. Prior to Payments New Zealand’s establishment, many of its functions were

undertaken by the New Zealand Bankers’ Association.

52. Payments New Zealand’s participants are banks that have joined one or more of its

clearing systems. Its members are payment system organisations (such as card schemes,

merchants, smaller non-shareholding banks, and payments infrastructure owners) that

want to be actively involved in the ongoing development and strategic direction of

payment systems. Its Board has 11 Directors made up of an Independent Chair, two

further Independent Directors and a Director appointed by each shareholder.

53. Payments New Zealand’s role is to:

• Manage the rules and standards of its payment systems.

• Encourage and facilitate new participants in its payment systems.

• Facilitate interoperability of payments between its Participants.

• Promote interoperable, innovative, safe, open and efficient payment systems.

54. In respect of the Consumer Electronic Clearing System, Payments New Zealand sets

standards relating to:

• What an EFTPOS card must have and do, such as the requirement for a PIN.

• What a merchant must do, such as make available a receipt.

• The minimum requirements of the terminals that cardholders use to initiate their

transactions.

• What, how, and when information gets exchanged through a switch.

55. Payments New Zealand has no (self-defined) role in determining the allocation of costs

or incentives within the retail payments system, or the business models that schemes

operate under.

1.4.3 Competition issues: Commerce Commission

56. The Commerce Commission (the Commission) has no prescribed role in relation to retail

payment systems, other than through its general role in enforcing the Commerce Act

1986, with the aim of promoting competition in markets for the long-term benefit of

New Zealand consumers.

57. In 2009, the Commission reached a settlement with the card schemes and major banks,

in which the parties made a number of undertakings to address what the Commission

considered was anti-competitive conduct in the operation of retail payment systems.

Annex 2 summarises the detail of the settlement.

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Retail Payment Systems in New Zealand: Issues Paper

58. The settlement with banks and schemes expired in 2013. However, the settlement

continues to have residual impact. This is because if any of the parties re-commence any

of the practices that the Commission deemed to be anti-competitive, they may be re-

challenged for potentially breaching the Commerce Act. The exception may be the level

of interchange fees, which is not necessarily a breach of the Commerce Act in itself.

MINISTRY OF BUSINESS, INNOVATION & EMPLOYMENT

Retail Payment Systems in New Zealand: Issues Paper

2. Payment systems in New Zealand

Introduction 2.1

59. Electronic payment systems are a key piece of infrastructure for commerce. While

alternative payment options (such as cash and cheques) remain, they are increasingly on

the fringe and compete poorly with their electronic competitors in a number of

dimensions. For example, electronic payments:

• Often provide greater convenience for consumers (such no need to visit a bank or an

ATM to withdraw cash, greater payment speed, and the ability to track and record

transactions).

• Allow consumers to purchase online with ease.

• Avoid the cost to merchants associated with processing cash and cheques (although

as discussed later, electronic payments are by no means costless).

• May reduce the risk of bad debts, and cash and cheque-related fraud and theft.

• In the case of credit cards, allow consumers to smooth consumption over time (this

also means that merchants do not need to operate their own credit schemes).

• Generate greater certainty of tax revenue for governments.

Box 1: The value of credit cards for merchants

Many of the stakeholders we spoke to emphasised the value that electronic payments,

particularly credit cards, provide to merchants. These included the ability to accept

international transactions, the avoided cost of cash acceptance, payment guarantees against

fraud and credit losses, prompt payment benefits, and increased sales from existing and

new customers.

As noted above, electronic payments, including credit cards, unquestionably provide a

number of benefits to both merchants and consumers. However, we consider that the levels

of some of these benefits are contestable. For example:

• Some parties noted that the value of average credit card transactions is higher than the

value of cash or debit transactions, and viewed this as evidence that credit cards

encourage higher levels of spending. An alternative interpretation is that any increase in

spending in the current period is countered by a reduction in spending in future periods,

and that higher credit card transaction values relative to other methods is correlation,

rather than causation. That is, higher-income individuals usually have larger than

average transaction sizes, and often use credit cards, but their transaction size would be

unlikely to change if they used a different payment method.

• Some stakeholders also noted that the cost of payment card fraud sometimes rests with

merchants, i.e. it is not always covered by scheme or bank payment guarantees.

• Similarly, while cash is unquestionably costly to process for merchants, we consider that

many of these costs are fixed, and unlikely to disappear without a complete withdrawal

of cash from circulation.

MINISTRY OF BUSINESS, INNOVATION & EMPLOYMENT

Retail Payment Systems in New Zealand: Issues Paper

60. New Zealand is highly regarded internationally for having one of the most developed,

dynamic, safe and secure payment systems in the world.

In line with this, uptake of

electronic payments in New Zealand is high: 93.8 per cent of adults have and use an

EFTPOS/debit card; New Zealand has the highest number of electronic payments made

per capita; and New Zealand has the lowest proportion of cash to GDP in circulation.

Furthermore, a 2014 survey ranked New Zealand as the number one global pioneering

payments market. This was based on consumer preferences for using electronic

payment options for low-value payments, willingness to use contactless forms of

electronic payments, and receptivity to changes in electronic payments.

61. As will be discussed later, much of this is attributable to the business model that

underpinned the rollout of proprietary EFTPOS, which encouraged almost universal

acceptance of card payments by merchants.

62. The remainder of this section outlines at a high level the main participants involved in

retail payment systems in New Zealand, the main types of card payment, and how these

payments are processed. It also briefly outlines emerging payment methods, such as

Apple Pay.

Parties in the system 2.2

63. There are a number of parties involved in any card-based transaction. The parties

involved and the interactions between them will differ depending on the type of card

being used. Nevertheless, the key parties and their key roles include:

• Cardholder/customer/consumer: Buys goods and services from merchants in

exchange for payment.

• Merchant: A party that provides goods or services in return for payment. Includes

retailers, wholesalers, utilities companies, and central and local government.

• Issuer: An organisation, typically a bank, which issues cards and provides debit

and/or credit services to consumers.

• Acquirer: An organisation, typically a bank, which provides access to the payment

system on behalf of merchants for the clearing and settlement of funds in a

transaction. An acquirer may or may not also be the bank that provides other

services to a merchant, such as lending and deposits.

• Scheme: Includes Visa, MasterCard, American Express and Diners. Schemes develop

technology and base product features, and set the commercial model and card

system rules. They may issue cards and attract merchants through banks (open

system – Visa and MasterCard) or directly (closed system – American Express, Diners

Club, etc.). Only relevant for non-proprietary-EFTPOS transactions.

• Switch: Infrastructure that sends the transaction information to the correct card

issuer or acquirer (depending on the type of transaction) so the funds can be taken

from the consumer's account and delivered to the merchant. Switching functions can

be performed by various parties, including stand-alone switches (most notably

Payments New Zealand. (2016). Benchmarking New Zealand’s payment systems. Unpublished.

Payments New Zealand. (2015). Are our payment systems as good as we think they are? Retrieved

from http://www.paymentsnz.co.nz/articles/are-our-payment-systems-as-good-as-we-think-they-are

RFIntelligence. (2014). Identifying global leaders in the race to transform national payment markets.

Retrieved from

http://www.rfintelligence.com/downloads/RFi_Global%20Report%20May%202014%20-

%20FINAL%20VERSION.pdf

MINISTRY OF BUSINESS, INNOVATION & EMPLOYMENT

Retail Payment Systems in New Zealand: Issues Paper

Paymark), schemes, and vertically-integrated terminal providers and customer

gateways (such as Verifone and Payment Express). The term here is distinguished

from an inter-bank switch that processes high-value payments, which is not further

discussed in this Issues Paper.

• Customer interface: Either the terminal hardware and software (for card-present

transactions) or digital customer gateway (for card-not-present transactions) through

which the customer makes a payment to a merchant.

Types of payment card and the types of transactions 2.3

64. This subsection outlines the types of debit and credit cards that are available, the types

of transactions that they can be used for, and how they are processed (or “switched”) in

the system. These relationships are summarised in Table 1. The method of switching is

important because it is tied to the business model applied to the transaction by banks

and schemes. This is discussed further in Sections 3 and 4.

Table 1: Cards, transactions and switches

Type of card Type of transaction Method of switch/network

Proprietary EFTPOS Swiped

Switch to issuer

(domestic ‘rails’)

Scheme debit

Inserted/swiped

Contactless/card-not-present

Switch to acquirer

(scheme ‘rails’)

Open or closed credit

Swiped/inserted/contactless/card-

not-present

2.3.1 Proprietary EFTPOS cards

65. Proprietary EFTPOS is the traditional form of debit payment card used in New Zealand.

According to data provided to us by one of New Zealand’s switches, it has a current

market share of roughly 46 per cent of transactions (by volume). It was introduced in

New Zealand in 1984 as a series of separately run switches and trials, and was

progressively rolled out and consolidated through the 1980s.

The system was

developed by banks as a means of reducing the high cost associated with processing

cash and cheque payments, largely without government involvement. Cards are issued

by a consumer’s bank, and while Payments New Zealand maintains an interoperability

standard for EFTPOS, there is no ‘owner’ of EFTPOS as a product.

66. For reasons explored later in this Issues Paper – and in contrast to other countries such

as Australia and Canada – EFTPOS as a technology in New Zealand remains

fundamentally unchanged from when it was introduced in the 1980s. Payment

information is transmitted via a magnetic strip on an EFTPOS card, which is less secure

than other methods of electronic transmission of information. In addition, at present,

EFTPOS cards can only be used to pay for face-to-face transactions (card-present

Wilkinson, M. (2011). Development of Retail Payment Systems since 1949. Master’s Thesis. Retrieved

from http://hdl.handle.net/10063/1747

MINISTRY OF BUSINESS, INNOVATION & EMPLOYMENT

Retail Payment Systems in New Zealand: Issues Paper

transactions), rather than online or over-the-phone sales (card-not-present

transactions). EFTPOS cards are also unable to be used for transactions made overseas.

67. Proprietary EFTPOS transactions are processed via a ‘switch to issuer’ model (domestic

rails – see Section 2.4).

2.3.2 Standard scheme debit cards

68. The first standard scheme debit card (named as such to distinguish it from contactless

scheme debit – see below) was introduced to New Zealand in 2006. The cards are issued

by a consumer’s bank using the technology and standards set by a card scheme – at

present, either Visa or MasterCard. In addition to a magnetic strip, scheme debit cards

also contain a chip that is inserted into a terminal, which provides greater security.

When inserted or swiped, scheme debit cards are currently processed under a ‘switch to

issuer’ model (discussed below) in the same way as proprietary EFTPOS, and funds are

accessed from the same bank account.

69. In addition to ‘card-present’ transactions, scheme debit cards can be also be used to pay

any merchant that accepts payments via the relevant scheme online, over the phone, or

overseas. In these instances, debit cards are ‘switched to acquirer’ (see below) process.

Scheme debit cards, when inserted or swiped, represent approximately 20 per cent of

transactions.

2.3.3 Contactless scheme debit

70. Since 2011, contactless debit cards (known as Visa PayWave and MasterCard PayPass)

have progressively entered circulation in New Zealand. In addition to inserting or

swiping a card, consumers have the option of ‘tapping’ their card against a terminal. This

allows payment for transactions below a threshold (currently $80, as set by Visa and

MasterCard) to be made contactlessly without the use of a PIN or signature.

71. When contactless functionality is used, scheme debit cards operate under a ‘switch to

acquirer’ model, even if the transaction exceeds the $80 limit and a PIN is required.

Swiping or inserting a contactless scheme debit card will see the transaction switched to

the issuer instead, in the same way that proprietary EFTPOS and standard scheme debit

transactions are processed. Contactless scheme debit is used for approximately 10 per

cent of transactions (but this share is rapidly growing).

2.3.4 Open credit card schemes

72. The first credit cards were introduced to New Zealand in the late 1970s. Open credit

card systems (often known as four-party systems) are the dominant form of credit card

system in New Zealand, and involve a card scheme (predominantly Visa and MasterCard)

working through issuers and acquirers (mainly banks) to attract consumers and

merchants to use and accept their product, respectively.

73. Open credit card schemes provide functionality similar to that of scheme debit cards,

with the obvious difference that they involve credit- rather than debit-based

transactions. It is the banks (as issuers), rather than card schemes, that provide

consumers with credit, and who guarantee the payment to merchants through their

acquirers. Open credit card systems are processed under a ‘switch to acquirer’ model

(see below).

74. Open credit cards have benefited from considerable investment and innovation on the

part of the schemes and banks. As a result of this, and significant marketing efforts

(discussed later), schemes have built an extensive international network of usage and

acceptance.

MINISTRY OF BUSINESS, INNOVATION & EMPLOYMENT

Retail Payment Systems in New Zealand: Issues Paper

75. Open credit cards often have contactless functionality but regardless of whether a credit

card is inserted, swiped or used contactlessly, the transaction is switched to the

acquirer. Open and closed (see below) credit cards are collectively used for

approximately 24 per cent of transactions.

2.3.5 Closed credit card schemes

76. The last major form of payment card is a closed credit card scheme (often known as a

three-party system). Under such a system, the scheme – such as American Express or

Diners Club – is also the issuer and acquirer of payment cards. That means that the

scheme directly works to attract consumers to use, and merchants to accept, their

payment cards. In addition, it is the scheme that is the provider of credit to a consumer.

77. Closed credit card schemes are processed under a ‘switch to acquirer’ model. We

understand that the market share of closed credit card schemes in New Zealand is

relatively low, at around 2 per cent of all card-based transactions.

Methods of switching 2.4

78. There are two main ways in which a card-based transaction can be processed, or

‘switched’: switch-to-issuer and switch-to-acquirer.

2.4.1 Switch to issuer (domestic rails)

79. When a proprietary EFTPOS card is used, or a scheme debit card is inserted or swiped,

the transaction is processed via a ‘switch to issuer’ model. Under this process:

• A switch sends the transaction details from the customer interface to the issuing

bank for authorisation.

• The issuing bank authorises or declines the transaction and returns the message to

the customer interface.

• The money is immediately debited (cleared) from the customer’s account at the time

it is authorised.

• Funds are settled between the cardholder’s and merchant’s financial institutions via

the inter-bank settlement process and deposited in the merchant’s account in a

lump-sum each day after inter-bank settlement.

2.4.2 Switch to acquirer (scheme rails)

80. A payment is processed using a ‘switch to acquirer’ model for all credit card

transactions, and for contactless, card-not-present, and international scheme debit

transactions. When this occurs:

• A transaction is switched from a customer interface to an acquirer (how it gets there

depends on the channel in which the transaction originates).

• The acquirer switches the transaction details to the card scheme.

• The scheme sends the authorisation request to the issuing bank.

• The issuing bank confirms whether the cardholder has sufficient available credit to

cover the purchase, and returns a response through the card scheme network, either

granting or denying authorisation.

• The acquirer receives the response and returns the message to the customer

interface.

MINISTRY OF BUSINESS, INNOVATION & EMPLOYMENT

Retail Payment Systems in New Zealand: Issues Paper

• The acquiring bank reconciles and transmits authorisations via the appropriate

scheme. Funds are deposited in a merchant’s account in a lump-sum after inter-bank

settlement, and debited from a customer’s balance in accordance with the relevant

scheme’s rules.

• Schemes settle funds with acquirers within 72 hours of the transaction occurring.

2.4.3 Variations

81. There are a number of variations to these two methods. These include cases where the

customer interface also acts as the switch, where the transaction bypasses a stand-alone

switch to be switched purely by a scheme, and when a transaction is processed by a self-

acquirer. These variations are not important for the purposes of this Issues Paper. As will

be discussed in Sections 3 and 4, what matters is whether a transaction passes through a

scheme – as all switch-to-acquirer transactions inherently do – since this determines the

business model under which the transaction takes place.

Trends in usage of payment options 2.5

82. In the year to March 2016, New Zealanders made more than 1.5 billion electronic card

transactions, representing more than $76 billion in expenditure. Transactions made

using electronic cards were responsible for 68.5 per cent of retail trade revenue in core

industries (excluding vehicle and fuel sales), an increase from 58.8 per cent in 2004 (see

Figure 1).

This means that the total share of other forms of payment (including cash,

cheques, bank transfers, and direct debits) is falling. In addition, the average value of

each electronic transaction is falling over time, reflecting the displacement of cash

(which is often used for low-value transactions).

Figure 1: Value of electronic card transactions as a percentage of total core retail

trade sales (Statistics New Zealand data)

83. Figure 2 shows that the split between credit and debit has remained relatively constant

since 2002.

Statistics New Zealand. (2016). Electronic Card Transactions. Retrieved from

http://www.stats.govt.nz/browse_for_stats/businesses/business_characteristics/electronic-card-

transactions-info-releases.aspx.

The slight upward trend in credit card usage in the last two years is misleading and represents the

miscategorisation of contactless debit transactions as credit transactions in the data provided to

Statistics New Zealand by New Zealand switches.

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

MINISTRY OF BUSINESS, INNOVATION & EMPLOYMENT

Retail Payment Systems in New Zealand: Issues Paper

Figure 2: Credit and debit card transactions as a percentage of electronic card

transactions (Statistics New Zealand data)

84. Even though the split between debit and credit spend has remained relatively constant,

there has been a notable shift in the types of transaction taking place over the last two

years, according to figures provided to us by one of New Zealand’s domestic switches.

Figure 3 (below) shows a significant decline in the value of transactions made with

proprietary EFTPOS cards, from around 44 per cent of card transactions in January 2014,

to 36 per cent in April 2016. There has also been a corresponding increase in the value

of contactless debit transactions, from 1 to 7 per cent of total transaction value. This has

taken the share of transactions that are processed via scheme rails from 40 to 49 per

cent of the transactions processed by this switch.

Figure 3: Value of electronic card transactions by card type (New Zealand switch

data)

2002Q4

2003Q2

2003Q4

2004Q2

2004Q4

2005Q2

2005Q4

2006Q2

2006Q4

2007Q2

2007Q4

2008Q2

2008Q4

2009Q2

2009Q4

2010Q2

2010Q4

2011Q2

2011Q4

2012Q2

2012Q4

2013Q2

2013Q4

2014Q2

2014Q4

2015Q2

2015Q4

Credit card usage as a proportion of total electronic card transactions value

Debit card usage as a proportion of total electronic card transactions value

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Credit Card Credit Card (Contactless) Scheme Debit (Contactless)

Scheme Debit (Swipe/Insert) Proprietary EFTPOS

Switch to

acquirer

(scheme

rails)

Switch to

issuer

(domestic

rails)

MINISTRY OF BUSINESS, INNOVATION & EMPLOYMENT

Retail Payment Systems in New Zealand: Issues Paper

85. Figure 4 provides the same transaction data, but by the number of transactions, rather

than their value. Switch-to-acquirer transactions form a lower proportion of this graph

than Figure 3, because the average value of credit card transactions is higher than for

other cards.

Figure 4: Number of electronic card transactions by card type (New Zealand switch

data)

Emerging payment methods 2.6

86. In addition to card-based payments, there are a number of other payment methods that

have been launched over the past few years, or are soon to be released. These can be

broken down into:

• Those that utilise existing scheme rails, which mean that a scheme debit or credit

card is required for payment.

• Those that do not rely on scheme rails. Many of these involve ‘direct entry’ to a

consumer’s bank account, otherwise known as a bank-to-bank transfer. While direct

entry methods are not new, the integration of them into a merchant’s point-of-sale

(POS) system is.

87. Payment methods can also be distinguished by whether they are used for card-present

or card-not-present (predominantly online) transactions, although over time this

distinction may blur.

88. Table 2 outlines many of these emerging methods.

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Credit Card Credit Card (Contactless) Scheme Debit (Contactless)

Scheme Debit (Swipe/Insert) Proprietary EFTPOS

Switch to

acquirer

(scheme

rails)

Switch to

issuer

(domestic

rails)

MINISTRY OF BUSINESS, INNOVATION & EMPLOYMENT

Retail Payment Systems in New Zealand: Issues Paper

Table 2: Types of emerging payment method

Name Rails Type of transaction Description

Apple Pay Scheme Card-present and

card-not-present

Contactless payment option that utilises

Apple devices instead of a card. Recently

launched in New Zealand for ANZ

customers. Utilises near-field

communication technology to enable

payment at any terminal where

contactless payments are accepted. In

addition, Apple Pay facilitates faster

payments within apps on Apple devices.

Android Pay Scheme Card-present and

card-not-present

Similar to Apple Pay, but for Android

devices. Not yet available in New

Zealand. Android Pay also facilitates

faster purchases within Android apps.

goMoney

wallet

Scheme Card-present Launched by ANZ in 2015. Similar to the

above, but operates from within the

existing ANZ mobile app on compatible

Android phones. GoMoney also supports

payments between ANZ accounts using a

cell phone number, so is also a direct

entry payment method in this respect.

Direct entry Card-not-present

ASB Virtual Scheme Card-present Similar to GoMoney wallet. ASB’s mobile

app also supports direct entry payment

through the use of cell phone numbers

or email addresses.

Direct entry Card-not-present

PayTag Scheme Card-present A sticker that a consumer attaches to

their phone (or anything else). This

utilises the same technology as that

contained in a contactless card. Offered

by ASB for Visa products, and Westpac

for MasterCard products.

PayPal Scheme or

direct entry

Card-not-present Allows consumers to pay for goods and

services online by entering their email

address and password. While generally

linked to a scheme card, a PayPal

account can also be funded through

direct entry methods. PayPal acts an

alternate acquirer for merchants who

may not have a relationship with an

acquiring bank.

MasterPass Scheme Card-not-present A digital wallet developed by MasterCard

that stores a consumer’s payment and

MINISTRY OF BUSINESS, INNOVATION & EMPLOYMENT

Retail Payment Systems in New Zealand: Issues Paper

shipping information in one location. This

allows consumers to make faster online

payments with merchants that have

integrated MasterPass into their

payment gateway. Despite being

developed by MasterCard, it can also be

used with Visa, American Express and

Diners Club cards.

Visa

Checkout

Scheme Card-not-present Similar to MasterPass.

POLi Direct entry Card-not-present Introduced in New Zealand in 2009.

When paying via POLi at an online

checkout, a consumer selects their bank

and enters their internet banking details,

POLi populates the transaction details,

and the consumer confirms payment.

While a number of online merchants,

including Air New Zealand and the

Warehouse accept POLi, banks have

expressed concern that payment

methods like POLi expose consumers to

increased risk and could be in breach of

banks’ terms and conditions.

Account2

Account

Direct entry Card-not-present Operated by Payment Express. Similar to

POLi.

PayHere Direct entry Card-not-present Launched by ASB in 2013. Under this

system, any ASB customer can pay a

participating merchant by entering their

cell phone number in the merchant’s

payment gateway, and confirming the

payment via their ASB mobile app. No

bank account details are exchanged, and

transactions are processed instantly.

Because PayHere sits within a merchant

gateway, businesses do not need to have

a banking relationship with ASB to accept

PayHere payments. Merchant

acceptance of PayHere appears to be

relatively low.

89. In addition, we understand that Paymark is in the process of finalising its own online

EFTPOS solution, which works similarly to PayHere.

90. Many of the above scheme-based methods utilise what is known as ‘tokenisation’. This

supports greater security – rather than providing the scheme card number to the

terminal, the terminal receives a device-specific ‘token’ and a one-use-only security

code. The token is translated into a credit card number only when it reaches the

scheme, meaning that only the scheme and the issuer have information about both the

MINISTRY OF BUSINESS, INNOVATION & EMPLOYMENT

Retail Payment Systems in New Zealand: Issues Paper

person and the transaction. Tokenisation also avoids the technical limitations that can

be associated with the unique card number on a physical card.

91. Crucially, other than switch-to-issuer transactions, there are not currently any

mainstream electronic payment methods in New Zealand that facilitate direct entry for

store-based (i.e. card-present) transactions. However, we are aware of industry

participants that are exploring options around the development of payment methods

that bypass scheme infrastructure through the use of:

• Blockchain – a digital ledger that records transactions which resides not on a single

server, but across a distributed network of computers. Ripple is a company that

utilises a distributed ledger process to enable participants to directly transact with

each other in real time, without the need for a central counterparty. The widespread

applicability of this technology to retail payments is seemingly some time away, but

should not be discounted.

• Application programme interfaces (APIs) – sets of routines, protocols, and tools for

building software applications. These have the potential to make it easier for industry

to offer bank-to-bank payment solutions that build off a common set of

infrastructure. For example, if banks allowed APIs to access their internet banking

platforms, it would allow non-banks to develop payment products over the top of the

issuer-customer banking relationship. The European Union’s revised Directive on

Payment Services (PSD2) is an example of an attempt by government to stimulate

competition in payments by allowing authorised third parties to use a consumer’s

bank details to make payments from their account.

Are there any other emerging payment methods that we have missed? If so, what is their

likely impact on the market?

MINISTRY OF BUSINESS, INNOVATION & EMPLOYMENT

Retail Payment Systems in New Zealand: Issues Paper

3. Market business models and

resource costs

93. The previous section described, at a basic level, how retail payments are processed

between parties. This section builds on that by describing the flows of fees and

inducements under the various business models operating in New Zealand.

94. First, we introduce the business model underpinning switch-to-issuer transactions,

which is relatively straightforward. We then move onto describing the interchange

business model that underpins switch-to-acquirer transactions. This is a complex set of

relationships that drives the uptake of each product as well as the market share of

various products. In particular, we focus on the following four relationships:

• Card issuers (generally banks) and consumers.

• Issuers and acquirers (and the flow of interchange fees).

• Acquirers (generally banks) and merchants (and the payment of merchant service

fees, MSFs).

• Consumers and merchants (and the use of surcharging and steering).

Switch-to issuer transactions 3.1

3.1.1 Overview

95. Very little flows in the way of fees and charges when it comes to transactions that are

switched to the issuer (run on domestic rails), including all payments made on

proprietary EFTPOS cards and inserted and swiped transactions made on scheme debit

cards.

96. Charges to cardholders for switch-to-issuer transactions are rare, and the marginal cost

of these transactions to merchants is zero. While merchants do face fixed costs for

terminal hire and the per-terminal cost of being connected to a switch, these costs are

carried by all merchants that take electronic card payments, regardless of which

payment types they accept. We therefore refer to switch-to-issuer transactions as being

“free” to merchants for the remainder of this Issues Paper.

97. As a result, the cost to banks of processing these transactions is met from other bank

income sources. A key (but still relatively small) cost of processing switch-to-issuer

transactions is the cost of switching itself, a function provided by Paymark and Verifone

for these transactions. The issuing bank pays these switching costs.

98. Figure 5 below shows the flows of fees and inducements that underlie the relationship

between different parties for switch-to-issuer transactions. Some of these flows are only

applicable in certain situations. The majority of the lines in the diagram are dashed,

which represents the fact that the flows of funds are not substantial in respect of switch-

to-issuer transactions.

MINISTRY OF BUSINESS, INNOVATION & EMPLOYMENT

Retail Payment Systems in New Zealand: Issues Paper

Figure 5: Fees and inducements in switch-to-issuer transactions

3.1.2 Customer-issuer relationships

99. It is important to see issuing banks’ competition for debit payment products as part of

their broader competition for personal banking consumers. This is because debit cards

are tied to a customer’s current account and a customer usually has their current

account with the bank that provides the remainder of their more significant banking

services (for example, their mortgage). This contrasts with credit cards, where it is more

common for someone to take out a credit card with a different bank to the one that

provides their other personal banking services.

100. There are flows of funds in both directions between customers and issuers related to

the maintenance of transactional bank accounts:

• Account fees, transaction fees and card fees that are paid from the customer to the

issuer.

• Interest, and occasionally rewards, that are paid to the customer by the issuer.

101. It is difficult to separate the flows relating to the operation of the account from flows

relating to the use of the payment functionality of a proprietary EFTPOS or scheme debit

card. Nevertheless, in general, banks do not charge consumers to use proprietary

EFTPOS or scheme debit cards, although some current accounts do attract a low

monthly fee that contributes to the overall cost of running the account. Per-transaction

fees were common when EFTPOS was introduced but over time they have been largely

competed away for most account types. Some banks also charge consumers a low

annual fee for a scheme debit card.

102. We have been advised that these charges do not fully offset the cost of providing these

debit payment options. Therefore, these costs are generally partially funded by banks

through other mechanisms, such as reduced interest payments to consumers on debit

balances (and interchange fees when the card is used contactlessly).

MINISTRY OF BUSINESS, INNOVATION & EMPLOYMENT

Retail Payment Systems in New Zealand: Issues Paper

103. Table 3 presents four (relatively representative) account types – tied to scheme debit

cards – that were available in January 2016.

Table 3: Examples of scheme debit fees, interest and rewards as at January 2016

(public data)

BNZ YouMoney

FlexiDebit Visa

ASB Omni

Westpac Access

Airpoints Debit

MasterCard

TSB Personal Visa

Debit

Account fee

$5/month

$3.50/month

Transaction

fee

$0.40/transaction

Card fee

$10.00 p.a.

$15.00 p.a.

$10.00 p.a.

Interest rate

(on savings)

0% p.a.

1.00% p.a. on

balances above $500;

1.50% p.a. on

balances above

$10,000.

Rewards

NA.

1 Airpoint per $250

spent.

NA.

104. There are generally no inducements to use proprietary EFTPOS or scheme debit cards.

This is likely to be less to do with a lack of competition in the debit card market, and

more because (with the exception of contactless debit transactions) there is no

interchange revenue to fund the inducements (see Section 3.2.3 for a discussion of

interchange). However, in 2015, Westpac introduced a modest rewards programme with

the launch of its Airpoints Debit MasterCard. So far, no other bank has followed suit in

launching a debit card rewards programme.

105. We are not aware of any major bank that does not continue to offer proprietary EFTPOS

cards to customers who request them. However, scheme debit cards have largely

become the default card offered by many issuers due to customer demand for the

greater functionality of scheme debit (such as online payment), and financial incentives

on issuers (see Section 4).

Banks have told us that the schemes now require all scheme

debit cards that are issued to contain contactless technology.

3.1.3 Issuer-acquirer relationships

106. A flow of funds between issuers and acquirers is known as interchange, and is discussed

further in Section 3.2.3 below. However, no interchange is charged on debit transactions

that are switched to issuer. This is a long-standing feature for proprietary EFTPOS

transactions and was continued for inserted and swiped scheme debit transactions

when scheme debit cards entered the market in 2006.

At least one major bank continues to have a high number of proprietary EFTPOS cards in circulation.

However, we know from Figures 3 and 4 (above) that usage of these cards is nevertheless declining

relatively quickly.

MINISTRY OF BUSINESS, INNOVATION & EMPLOYMENT

Retail Payment Systems in New Zealand: Issues Paper

107. Our understanding is that New Zealand is relatively unique in the schemes not charging

interchange on the majority of scheme debit transactions.

The explanation for this

situation appears to be largely that, because merchants do not pay a fee to accept

proprietary EFTPOS payments (see below), few merchants would have accepted scheme

debit cards upon their introduction were there an associated charge. In addition,

because (at introduction) no issuer offered rewards on scheme debit products, there

was no need to meet the cost associated with these inducements.

3.1.4 Acquirer-merchant relationships

108. Merchants face costs as part of their overall relationship with a bank. However, because

switch-to-issuer transactions operate outside of the interchange business model,

merchants do not face any per-transaction charge for these payments. This traces back

to the introduction of EFTPOS in the 1980s, in which banks – keen to see a shift away

from cash and cheques and their associated cost – placed charges for EFTPOS on

consumers, rather than merchants, in order to drive acceptance.

109. As noted above, over time these charges on cardholders have largely been competed

away, meaning banks receive no direct revenue source from the processing of EFTPOS

and standard scheme debit cards. At least one acquirer attempted to introduce a MSF

for proprietary EFTPOS in the 1990s, but quickly removed these in the face of heavy

attrition from merchant customers.

Switch-to-acquirer transactions 3.2

3.2.1 Overview

110. Scheme-based transactions involve a significantly more complex series of fees and

inducements that flow between more parties in the system. In this Issues Paper, we call

the nexus of relationships underpinning scheme-based transactions the “interchange

business model”. This business model applies to:

• All open (Visa and MasterCard) credit cards.

• Contactless scheme debit transactions.

• Card-not-present scheme debit transactions (mainly online).

• International scheme debit transactions.

111. Figure 6 below shows the main flows of fees and inducements in switch-to-acquirer

transactions. Once again, not all flows are applicable to all situations. Bold lines

represent flows that are ‘core’ to understanding the system, while dotted lines

represent secondary flows.

However, there are many markets worldwide in which EFTPOS-like systems have been developed

without the use of interchange.

MINISTRY OF BUSINESS, INNOVATION & EMPLOYMENT

Retail Payment Systems in New Zealand: Issues Paper

Figure 6: Fees and inducements in switch-to-acquirer transactions

3.2.2 Customer-issuer relationships

112. Generally speaking, there are three variables on which credit card issuers compete for

credit card customers: card annual fees, interest rates on credit, and reward

programmes. There are therefore three main types of credit card offered in the market

at present: low fee/low rewards/high interest rate; high fee/high rewards/high interest

rate; and low fee/no rewards/low interest rate. Table 4 provides examples of five

(relatively representative) credit cards available in January 2016.

MINISTRY OF BUSINESS, INNOVATION & EMPLOYMENT

Retail Payment Systems in New Zealand: Issues Paper

Table 4: Example of credit card fees, interest and rewards as at January 2016

ANZ Low

Rate

MasterCard

ASB Visa Gold

Rewards

Platinum

Kiwibank

Airpoints

Standard

MasterCard

American

Express Air

New

Zealand

Westpac Airpoints

World MasterCard

Card fee

$58 p.a.

$150 p.a.

$65 p.a.

$0 p.a.

$390 p.a.

Interest

rate (on

credit)

13.90% p.a.

20.95% p.a.

19.95% p.a.

16.95% p.a.

Rewards

NA.

$1 True

Rewards per

$100 spent,

travel

insurance.

$1 Airpoint

dollar per

$120 spent.

1 Airpoint

per $100

spent.

1 Airpoint per $65 spent,

1 status point per $225,

travel insurance,

extended warrantee

insurance, airport lounge

access, valet parking.

113. It seems more likely that a consumer will switch bank on the basis of a credit card

offering than a debit card – for one thing, a credit card customer does not need to hold

funds with an issuer, while a debit customer does. In line with this, competition between

issuers in relation to credit cards appears to be relatively intense. Issuers invest

significantly in marketing to attract customers to their product. This appears to be

happening through both churn of existing customers between issuers, and the drawing

of non-credit card users to credit. For example, Reserve Bank data

shows domestic

inflation-adjusted spending on credit cards has increased nearly six-fold since 1993 (see

Figure 7). In fact, in the year to February 2016, domestic spending on credit cards

increased by 13.6 per cent on the year before.

114. Having said this, as noted above, the share of credit card transactions as a proportion of

all electronic card transactions has remained relatively constant since 2002 (when

records began) indicating that there has been a similar growth in the level of

transactions carried out on debit cards over this period.

Figure 7: Monthly spend on New Zealand-issued credit cards, seasonally adjusted,

2016 dollars ($ millions, RBNZ data, MBIE calculations)

Reserve Bank of New Zealand. (2016). Credit card spending. Retrieved from

http://www.rbnz.govt.nz/statistics/c13

MWE Consulting. (2016). New Zealand Cards Report: February 2016.

$500

$1,000

$1,500

$2,000

$2,500

$3,000

$3,500

MINISTRY OF BUSINESS, INNOVATION & EMPLOYMENT

Retail Payment Systems in New Zealand: Issues Paper

115. Reserve Bank data

also shows that credit card usage may be increasing for reasons

other than consumers needing credit. Figure 8 shows that the revolve ratio on credit

cards – that is, the ratio of interest-bearing advances to all advances – is at its lowest

point since records began, with 36 per cent of balances attracting no interest. We

assume that interest-bearing advances are spending that is dependent on credit (since it

is not being paid off before it attracts interest) and that non-interest-bearing advances

are spending that is not dependent on credit (or, at the most, only on very short-term

credit, since it is paid off within a very short timeframe). Therefore, the decrease in the

revolve ratio suggests that consumers may be being induced to use credit more than

they otherwise would.

3 What explains the decline in the revolve ratio on credit cards?

116. Similarly, the ratio of credit card expenditure to outstanding balances is also increasing.

These trends align with bank assertions that while around half of credit card customers

use their cards primarily for the credit functionality, another 40 per cent are using them

primarily on the basis of the rewards they provide.

Figure 8: Revolve ratio on credit cards (RBNZ data, MBIE calculations)

117. Issuers have three main revenue streams from which the costs associated with credit

cards are funded: annual fees, interchange income (discussed later), and interest rates.

Ultimately, these all feed into the same ‘pool’ of funds for the bank, so they cannot be

considered completely separately. However, at least for one major bank, these revenue

streams are generally tied to different costs:

• Annual fees to customers are generally used to cover costs related to the physical

cost of the card, customer service and administration, and statements. They are also

used to fund some benefits of holding or using the card, such as travel insurance,

concierge services and Visa Entertainment.

• Interchange income is used to pay for rewards such as Air New Zealand Airpoints, or

issuer-specific cash-back or voucher-style rewards programmes, which are tied to the

value of spending on a card. Rewards are determined by the issuer, rather than the

Reserve Bank of New Zealand. (2016). C12: Credit card balances. Retrieved from

http://www.rbnz.govt.nz/statistics/c12

10%

20%

30%

40%

50%

60%

70%

80%

Jul 2000

Mar 2001

Nov 2001

Jul 2002

Mar 2003

Nov 2003

Jul 2004

Mar 2005

Nov 2005

Jul 2006

Mar 2007

Nov 2007

Jul 2008

Mar 2009

Nov 2009

Jul 2010

Mar 2011

Nov 2011

Jul 2012

Mar 2013

Nov 2013

Jul 2014

Mar 2015

Nov 2015

MINISTRY OF BUSINESS, INNOVATION & EMPLOYMENT

Retail Payment Systems in New Zealand: Issues Paper

scheme. Interchange income may also cover scheme fees and the cost of fraud,

meaning that not all interchange income necessarily flows to cardholders.

• Interest income from interest-bearing balances is used to pay for the cost of credit

(including the interest-free period) and bad debts, rather than the cost of payment

per se. For this reason, it is not the focus of this study. Nevertheless, Reserve Bank

data

shows that weighted average interest rates on credit card balances have

remained relatively stable over the past 15 years, at around 18 per cent on interest-

bearing balances, and 12 per cent across all balances (i.e. the average of the balance

attracting interest and the balance not attracting interest).

118. One bank provided us with information about the levels of rewards paid out, relative to

the annual fees collected on credit cards over the last three years. While the two are not

necessarily connected, the rewards paid out have substantially exceeded the annual

fees collected in all three years, with significant growth in rewards paid (but not annual

fees collected) out over the last two years.

119. One bank has told us that more than 70 per cent of credit card spending attracts

rewards (this will vary by issuer depending on their product range). Reward levels are

difficult to track using publicly available data due to frequent changes in the structure of

reward programmes. However, data provided to us by a major bank shows that the level

of reward per dollar spent was relatively flat between 2009 and 2014, before rising

significantly in 2015 and 2016. Much of this appears to be attributable to increased

competition between issuers to attract (and retain) the customers of BNZ, following the

end of its Airpoints arrangement with Air New Zealand.

120. The overall increase in rewards paid out therefore likely reflects two factors:

• increased spending on rewards-based credit cards; and

• an increase in the rewards offered per dollar spent.

Figure 9: Examples of the strong competition between banks for rewards

121. Much of both the increased spending on rewards-based credit cards and the increase in

the average level of rewards per dollar is likely attributable to the increase in the

Reserve Bank of New Zealand. (2016). C12: Credit card balances. Retrieved from

http://www.rbnz.govt.nz/statistics/c12

MINISTRY OF BUSINESS, INNOVATION & EMPLOYMENT

Retail Payment Systems in New Zealand: Issues Paper

number of customers on ‘premium’ credit cards (those with high rewards, and

correspondingly higher interchange fees – discussed later) in recent years. This has been

a consistent theme of our discussions with stakeholders, and is confirmed by data

provided to us by one bank, which shows that the number of premium cards issued by

that bank has quintupled (albeit from a relatively low base) since 2008.

122. Interest-free periods are another form of credit card inducement. These generally last

for up to either 44 or 55 days, depending on the period in a billing cycle in which a

payment is made. These periods serve to make credit card payments more attractive by

making the cost of short-term credit effectively zero – equivalent to debit, and much

cheaper than other forms of credit such as overdrafts, which do not generally have

interest-free periods.

123. Closed credit cards schemes such as American Express generally operate similarly to

open schemes in respect of fees and rewards.

3.2.3 Issuer-acquirer relationships

The theory of interchange

124. The flow of funds between issuers and acquirers that takes place under switch-to-

acquirer transactions is known as an interchange fee. This generally flows from the

acquirer to the issuer as a percentage of the value of a transaction. Interchange allows

schemes, issuers, and acquirers to place different prices on cardholders and merchants

in a way that promotes the widest possible use and acceptance of a scheme’s product.

125. These prices need not be equal for both parties, and they can even be negative (i.e. a

party can be paid to use the product). This is generally determined by the maturity of

the scheme and the relative price sensitivities of consumers and merchants. The fact

that interchange generally flows from the acquiring bank (from merchants) to the

issuing bank (to subsidise use by cardholders) is seen by The European Central Bank

(ECB) as evidence that merchants are less price-sensitive with respect to the cost of

payment than consumers.

126. This means that merchant acceptance of card schemes will vary less in response to an

increase in the price of accepting payment than consumer use of card payments in

response to a change in the price they face. According to the ECB, this is due mainly to

the fact that accepting card payments has become a necessity for merchants in many

business sectors. Another way of explaining this is that merchants “multi-home” (i.e.

they feel the need to accept most forms of payment), whereas card-holders “single-

home” (i.e. most consumers choose the payment types that suit them best, rather than

holding a whole suite of cards). Therefore, increasing the price of acceptance to

merchants has a relatively small impact on acceptance, whereas reducing the price to

consumers can plausibly induce them to switch from one card brand or issuer to

another.

127. As explained in a 2012 paper

, without interchange, issuers and acquirers would both

set prices independently of each other in order to maximise their own profit. The paper

argues that without interchange, issuers would not take into account the externality

that attracting additional cardholders and card usage generates additional revenues for

the acquirer by increasing the number of card transactions. The issuer would therefore

Borestam, A., & Schmiedel, H. (2011). Interchange fees in card payments. Occasional Paper Series No.

131. Retrieved from https://www.ecb.europa.eu/pub/pdf/scpops/ecbocp131.pdf

Rysman, M., & Wright, J. (2012). The Economics of Payment Cards. Retrieved from

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2183420

MINISTRY OF BUSINESS, INNOVATION & EMPLOYMENT

Retail Payment Systems in New Zealand: Issues Paper

tend to set its price to cardholders too high in terms of maximising the profits of the

system as a whole, resulting in fewer card transactions. There is also an externality in

the reverse direction, in that each additional merchant acquired will generate additional

transactions and revenue for the issuer.

128. This is not unique to retail payment systems. Interchange is a perfectly rational profit-

maximising mechanism from the perspective of a network owner where there is a two-

sided market. Actively balancing prices on both sides of the market is particularly

valuable when a network is first being built up. Another example of where an

interchange-like mechanism is used is the newspaper industry, in which the newspaper

must balance the cost of production between readers and advertisers, with much of the

cost falling on the latter in practice. While there is no explicit interchange fee in such a

situation, there is an internal transfer of value.

4 Do you agree with our explanation of the rationale for interchange?

Interchange in practice

129. In New Zealand, interchange is charged on virtually all Visa and MasterCard credit card

transactions. Since 2009, interchange caps have been set individually by the schemes (as

noted in Annex 2, prior to 2009, it was set collectively between each scheme and its

issuers). The schemes set a complex range of interchange caps depending on the

merchant type and the form of card used. For example, schemes set a lower interchange

cap for strategic merchants – a handful of large merchants such as supermarkets and

fuel chains.

130. Schemes receive no revenue from the interchange fee – this is passed from the acquirer

to the issuer.

131. Issuers are free to charge interchange below the cap. We understand that generally,

issuers charge the maximum allowable interchange, with two exceptions:

• In the case of whole categories of ‘merchants’, such as charities, in which issuers

notify schemes that they wish to charge a lower rate of interchange (this is reflected

in the reported average weighted interchange figures).

• When large merchants negotiate directly with the issuing side of the merchant’s

acquirer to have them charge a lower rate of interchange on transactions made by

the issuer’s customers with the merchant. This is distinct from merchant-scheme or

merchant-acquirer negotiations that may also take place (see below), and is not

captured in the interchange figures that have been provided to us. It is unclear how

often these negotiations actually result in lower interchange being applied.

132. While the two open credit card schemes appear to compete vigorously to attract issuers

and merchants, this competition appears to have the natural impact of increasing,

rather than decreasing, the interchange caps that are set by the schemes. This is

essentially because:

Whether interchange is still justifiable on this basis in a mature, near-ubiquitous market – as with Visa

and MasterCard – is contested in academic literature.

Issuers appear to have very little reason to agree to charge a lower rate of interchange. This is

because we understand that margins on acquiring services for large merchants are generally relatively

low. Therefore, there is little incentive for the issuer to reduce its revenue stream so that the acquirer

will win the merchant’s business. In fact, there is actually a disincentive on the issuer in that if the

merchant’s services were provided by another acquirer, then that acquirer would have to pay the issuer

the full interchange rate.

MINISTRY OF BUSINESS, INNOVATION & EMPLOYMENT

Retail Payment Systems in New Zealand: Issues Paper

• Issuers prefer high interchange fees, because it makes it easier to attract cardholders

through greater rewards and inducements, and allows them to recoup the costs of

processing payments.

• Acquirers prefer low interchange fees, because it makes it easier to attract

merchants.

• As noted above, merchants appear to be less price sensitive than consumers in

regards to the cost of payment. This flows through to the sensitivity of issuers and

acquirers, to the point where the issuer is more sensitive to a decrease in

interchange than the acquirer is to an increase. Moreover, merchants are able to

pass costs through to consumers in the form of higher overall prices.

• Most acquirers are also issuers, and therefore any increase in cost to an acquirer

through an increase in interchange is directly netted off as an increase in revenue to

the issuer (assuming no change in card usage). This means that the acquiring side of

an issuing bank is likely to be considerably less opposed to an increase in interchange

than a solo-acquirer (rare in New Zealand).

• As markets mature and change, merchants become less price-sensitive to the cost of

accepting payment as consumer demand to use a particular payment method

increases. This makes it relatively more attractive to increase interchange to attract

additional cardholders, rather than decrease it to attract additional merchants.

133. The level of competitive constraint on interchange caps will ultimately depend on

merchants’ willingness to pay the resulting MSF (see below). This in turn depends on

how close consumers see other forms of payment as substitutes. For example, the

declining use of proprietary EFTPOS cards would suggest that consumers now see it as

less of a substitute for scheme products than previously, and there are seemingly no

mainstream ‘direct entry’ payment options on the immediate horizon to compete with

scheme products in the card-present context.

5 Have we accurately described the incentives on parties in relation to interchange?

Credit interchange rates

134. Current interchange caps are published publicly on the website of Visa and MasterCard,

although a record of the changes over time (or the effective rate, where this differs from

the cap) is not. As an illustration of the broad range of interchange categories available,

Table 5 outlines the interchange rates applicable to Visa credit and debit cards, as at

May 2016.

Of note is the significantly higher interchange cap that is applicable to Visa

Platinum as opposed to Visa Classic or Visa Gold cards for electronic and standard

transactions (which was adjusted up in 2015 from 1.85 to 2.1 per cent). This arguably

creates a significant incentive for issuers to steer customers towards premium credit

cards.

Visa New Zealand (n.d.). Interchange. Retrieved from

http://www.visa.co.nz/aboutvisa/interchange/interchange.shtml

MINISTRY OF BUSINESS, INNOVATION & EMPLOYMENT

Retail Payment Systems in New Zealand: Issues Paper

Table 5: Interchange rates applicable to Visa credit and debit cards (May 2016)

Credit Debit

Fee Program

Visa Classic

Visa Gold

Visa

Platinum

Visa

Signature

Visa

Commercial

Visa

Consumer

Visa

Commercial

Industry Program – Charities 0.39%

Strategic Merchants – Card Present

(CP) – Rate 1

0.50% $0.04

Strategic Merchants – CP – Rate 2 0.55% $0.05

Strategic Merchants – Card Not

Present (CNP) – Rate 1

0.50%

Strategic Merchants – CNP – Rate 2 0.55%

Strategic Merchants – CP and CNP

(Credit) and CNP (Debit) – Rate 3

0.60% 0.60%

Strategic Merchants – CP and CNP

(Credit) and CNP (Debit) – Rate 4

0.70% 0.70%

Strategic Merchants – CP and CNP

(Credit) and CNP (Debit) – Rate 5

0.80% 0.80%

Strategic Merchants – CP and CNP

(Credit) and CNP (Debit) – Rate 6

0.98% 0.98%

Industry Program – Government,

Utilities & Telecom

NZ$0.70 NZ$0.70

Industry Program – Insurance NZ$1.00 NZ$1.00

Industry Program – Recurring

Payments

0.70% 0.70%

Electronic (CP) 0.85%

2.10% 2.30% 2.00%

0.30%

Standard (CNP) 1.25% 1.25% 2.00%

135. One scheme has provided data which shows that the average weighted interchange

charged for credit was relatively flat between 2009 and 2015, before rising modestly in

2016. Another scheme provided us with data showing that of the 11 changes it had

made to credit interchange rates since March 2014, 9 of them were decreases.

However, this does not necessarily reflect the direction of change for overall weighted-

average interchange.

136. We have also been provided with data by a bank which shows that between 2012 and

2015, for its merchant base:

• Overall weighted average interchange fees for (open) credit cards increased by

around 9 per cent.

• Credit interchange rates charged to acquirers of small merchants increased by

around 16 per cent.

• Credit interchange rates charged to acquirers of strategic merchants (generally the

largest merchants, such as supermarket and petrol station chains) decreased by

around 20 per cent. We understand that this was as a result of direct pressure placed

on schemes by large merchants, following a reduction in the rebates received from

MINISTRY OF BUSINESS, INNOVATION & EMPLOYMENT

Retail Payment Systems in New Zealand: Issues Paper

acquirers on expiry of the settlement with the Commerce Commission in 2013 (see

below).

137. For this acquirer, the effect of these changes is that interchange charged for small

merchants is now around two and a half times the interchange charged for strategic

merchants.

Why are interchange rates falling for large merchants but increasing for small-medium

merchants?

138. Overall, the data we have received from banks and schemes tells a similar story – while

weighted average interchange rates fluctuate, and growth is not rapid, the trend is up,

rather than down.

139. There is no interchange on closed credit cards such as American Express. This is because

American Express is both the issuer and acquirer. Nevertheless, American Express still

implicitly replicates an interchange fee by balancing the charges it places on cardholders

and merchants in order to maximise profits.

Interchange for debit transactions

140. Card-not-present and contactless scheme debit transactions work under the same

interchange business model as credit transactions. Interchange fees for card-not-present

and contactless scheme debit transactions are generally lower than the equivalent credit

interchange rate. Contactless debit interchange was justified by schemes on the basis of

the significant investment that the development of the technology required.

Nevertheless, the interchange cap has been falling over time, largely to encourage

merchant acceptance in the context of merchants continuing to face no direct cost from

inserted and swiped debit transactions.

141. Data provided by a bank shows that average debit interchange for its merchant mix fell

significantly between 2012 and 2015. Much of this decrease is seemingly attributable to

the shift from debit interchange being applied only to card-not-present (online)

transactions, to it also being applied (at a lower rate) to contactless transactions as their

uptake increased.

Acquirer-merchant relationships

Structure of merchant service fees

142. Merchant service fees (MSFs) are a key feature of payment options that operate under

the interchange business model (credit cards and contactless and card-not-present

scheme debit transactions). Acquiring banks collect MSFs from merchants to pay for

scheme fees (see below), switch fees, float costs (the cost of paying a merchant before

the issuer reimburses the acquirer), merchant servicing costs, as well as a bank margin.

Most importantly, however, the MSF covers the interchange fee paid to the issuing

bank. Stakeholders consistently told us that around 70 to 80 per cent of the MSF is paid

out as interchange. As discussed above, no MSF is charged on switch-to-issuer (domestic

rails) transactions and there is no associated interchange fee.

143. Prior to the Commission’s 2009 settlement (see Annex 2), we understand that most

acquirers simply provided merchants with one ‘blended’ MSF, which averaged out the

cost of accepting various payment types into a fixed percentage per transaction,

regardless of the mix of cards used in a particular month. These blended MSF

percentages are fixed for a given period of time.

144. As part of the 2009 settlement, acquirers are also required to offer merchants:

MINISTRY OF BUSINESS, INNOVATION & EMPLOYMENT

Retail Payment Systems in New Zealand: Issues Paper

• Unblended MSFs, which are separate fees for Visa and MasterCard transactions,

enabling merchants to see the cost of accepting each scheme’s credit cards.

• Unbundled MSFs, which are separate fees for all types of Visa and MasterCard

transactions, allowing merchants to see the cost of accepting every type of card.

145. In practice, acquirers differ in the bundling options that they provide to merchants. For

example, one bank told us that it splits out credit and debit merchant service fees by

default, whereas other banks do not. Unbundling is known as cost-plus pricing, in that

acquirers pass along the interchange fee that they are charged, with a margin built on

top.

146. All of the banks that we spoke to told us that they prefer to unbundle. This is likely

because, when an acquirer sets a bundled rate, it does so based on the estimated mix of

high- and low-cost transactions that a merchant will process. Unbundling avoids the risk

for a bank that a merchant will process a greater proportion of high-cost transactions

than anticipated.

147. There has not been great uptake of unbundling by merchants – banks have told us that

only around 5 per cent of merchants choose to unbundle. This is likely to be because

unbundled rates are more difficult for all but the largest merchants to understand, and

because unbundling creates greater cost uncertainty for merchants. We spoke to a

range of merchants and noted that while some of the largest merchants had the

capacity and financial incentive to understand MSFs, many others did not. Retail New

Zealand noted that many smaller merchants would not take the time to unpick MSFs, as

these costs are only one of many costs they face.

Level of merchant service fees

148. Based on information about MSFs provided to us by a bank, we estimate that the total

cost of MSFs to merchants in 2015 from transactions made on scheme rails was $461

million.

In addition, Retail New Zealand has conducted surveys of its members’ MSFs in

2014 and 2015. According to its survey, which was weighted by industry sector (but not

necessarily representative of the economy as a whole), merchants faced an average MSF

in 2014 of 1 per cent for contactless debit and 1.4 per cent for Visa and MasterCard

credit. In the 2015 survey, merchants’ average MSF for contactless debit remained at 1

per cent, with the MSF for credit rising to 1.7 per cent.

These figures somewhat exceed

those provided to us by banks in both their rate and level of growth between 2014 and

2015. Using the Retail New Zealand figures, total MSFs in 2015 would have been closer

to $589 million.

149. Based on information provided to us by a bank, headline average MSFs appear to track

closely to changes in interchange, with a modest rise in MSFs over the last three years in

line with a growth in weighted average interchange. In line with this, headline acquirer

margins have seemingly remained relatively constant. However, we understand that

these figures do not tell the full story. Some banks provide merchants with rebates to

attract or retain them as a customer and these rebates are not factored into the

Covec estimated that the total cost of MSFs to merchants in 2015 was $373 million, however this is in

2010 dollars, and utilises different sector coverage figures and MSF assumptions.

These figures include merchants who pay the same bundled MSF for debit and credit, so a merchant

receiving an unbundled MSF would generally face a lower contactless rate, and higher credit rate, than

the reported averages.

MINISTRY OF BUSINESS, INNOVATION & EMPLOYMENT

Retail Payment Systems in New Zealand: Issues Paper

headline MSF figures. However, we understand that rebate levels have reduced since

2013, potentially increasing acquirer margins.

150. Any competition that occurs between acquirers for merchants is seemingly restricted to

the acquiring margin, with the interchange rate charged by the issuer acting as a

relatively hard floor for overall MSFs.

151. A consistent theme of our discussions with stakeholders was the gap between the MSFs

faced by large and small merchants. This appears to be largely a function of the differing

interchange caps set by schemes, with much lower caps set for strategic merchants than

for smaller merchants. However, as will be discussed later (see Section 4.4), while

interchange caps for strategic and non-strategic merchants are diverging, this is not

necessarily leading to a divergence in MSFs to the same extent.

152. Despite the higher MSFs that smaller merchants face, they are – in some cases – able to

negotiate discounts. For example, Retail New Zealand has negotiated a (seemingly

modest) reduction in MSFs for its members with Westpac of 1.49 per cent where

transactions exceed $150 on average, 1.64 per cent where transactions are below $150

on average, and 1.79 per cent for card-not-present transactions. However, this rate is

limited in that it only applies to bundled fees.

153. A final complicating factor is the introduction of contactless debit, and its associated

MSF. Because the interchange and associated MSF for contactless debit is generally

lower than for credit, the growth of contactless transactions (and the inclusion of

contactless debit in the bundled figure) can, in some instances, give the impression that

bundled MSFs are falling. However in reality, the total amount paid in MSFs is

increasing. This is because contactless debit payments have replaced proprietary EFTPOS

and cash, which do not attract a MSF.

154. Closed credit card schemes such as American Express also charge merchants a MSF for

accepting their cards (in this case, directly). The business model of American Express

differs slightly from those of Visa and MasterCard. It charges a higher MSF on the

premise that it provides merchants with higher-value consumers than its competitors,

among other benefits. As a result, merchant acceptance of American Express and other

closed credit cards is significantly lower than for open credit cards, and mostly limited to

larger merchants.

155. American Express charges a flat rate to merchants, regardless of the type of American

Express card used. Nevertheless, American Express does differentiate its MSFs between

merchants, depending on relative bargaining power and (relatedly) the level of value

that a merchant considers that American Express provides.

3.2.4 Scheme-merchant relationships

156. The situation in respect of MSFs is further complicated by the direct negotiation that

occurs between schemes and a handful of large merchants regarding credit cards and

contactless scheme debit. Under these negotiations, these merchants receive an

additional rebate off their MSF, in addition to the lower base interchange rates that they

face as a ‘strategic’ merchant (as shown in Table 5 above). In return, schemes may

The Commerce Commission’s 2009 settlement, which expired in 2013, required banks to reduce the

weighted-average interchange fee that was applied overall. Banks chose to comply with this by giving

rebates to merchants.

As noted above, merchants have the ability to negotiate directly with issuers to seek to reduce the

interchange charged on transactions at their businesses. However the extent to which this actually

results in lower interchange rates being applied is unclear.

MINISTRY OF BUSINESS, INNOVATION & EMPLOYMENT

Retail Payment Systems in New Zealand: Issues Paper

impose conditions on merchants, such as agreeing not to surcharge for a period of time,

or agreeing to enable contactless payment. These agreements are not in breach of the

Commission’s 2009 settlement because they are not a ‘standard contracting procedure’.

They are also not taken into account in the published interchange rates.

3.2.5 Customer-merchant relationships

157. Merchants are able to influence the payment option a consumer uses by:

• Surcharging, where merchants add an additional fee for particular payment options

to recoup the cost of accepting payment without passing on an overall price increase

(and thereby sending more accurate price signals to the consumers).

• Steering, which means not accepting (or discouraging) some forms of payment, or

preventing a payment type being used in some circumstances (such as low-value

transactions) if it is generally accepted.

Surcharging

158. The prevalence of surcharging by merchants for switch-to-acquirer transactions is

relatively low in New Zealand. In a 2012 survey of merchants, less than 10 per cent

(weighted by turnover) reported surcharging customers for credit card payments.

Similarly, in Retail New Zealand’s 2016 survey of its members, almost none of the

respondents reported charging their customers extra for the use of certain payment

methods. Nevertheless, there are some sectors in which surcharging for credit and card-

not-present debit is more prevalent. These include hotels, airlines, and central and local

government. We are unaware of any merchant that surcharges for contactless debit

payments.

159. Historically, there appear to have been four main barriers to surcharging:

• Prior to the Commerce Commission’s 2009 settlement, the schemes imposed ‘no

surcharge rules’, which prohibited surcharging of credit card transactions by

merchants. American Express, which was not part of the settlement, still prohibits

surcharging by merchants, although its success in enforcing this condition is

seemingly limited.

• Surcharging can be technically difficult. While we understand that many terminals

can now detect the type of card being used, this still needs to be linked into the

merchant’s POS system, or otherwise the surcharge will need to be manually applied.

• Lack of information about the cost of accepting different payment types. Because

merchant uptake of unbundling is low (for whatever reason), many merchants will

not have enough information about the cost of accepting different cards from their

bank or the scheme to be able to make an informed decision about whether they

should surcharge and if they do, at what rate.

• Customers react negatively to surcharging. An Australian survey sponsored by

American Express

found that 93 per cent of consumers wanted surcharges

Commerce Commission (2013). Evaluation of the 2009 interchange and credit card settlements.

Retrieved from

http://www.comcom.govt.nz/business-competition/enforcement-response-register-

commerce/investigation-reports/research-report-evaluation-of-the-2009-interchange-and-credit-card-

settlements

RDG Insights. (2015). Every Good Buy is the Next Hello. Retrieved from

http://www.retaildoctor.com.au/wp-content/uploads/2015/03/RDG-Insights-Payment-Surcharges-

Report_03032015.pdf.

MINISTRY OF BUSINESS, INNOVATION & EMPLOYMENT

Retail Payment Systems in New Zealand: Issues Paper

removed, 43 per cent left with a bad impression of the business that surcharged

them, and 25 per cent claimed that they would not return to a business that

surcharged them. While these sorts of opinions are not necessarily reflected in actual

behaviour

, this sort of customer reaction made all of the merchants we spoke to

incredibly reluctant to surcharge, for fear of being the first mover and thereby losing

significant business. As a result, stakeholders we spoke to noted that surcharging is

often most prevalent in sectors where merchants have some degree of market

power.

Steering

160. In contrast, a reasonable portion of merchants steer in relation to switch-to-acquirer

(scheme rails) transactions. One bank that we spoke to told us that around 25 per cent

of their merchant customers did not accept credit. Another, which has a higher

proportion of small merchants as customers, placed non-acceptance of credit cards by

their merchants in the region of 40 per cent.

161. These figures may, however, understate the level of credit card acceptance, and

therefore the countervailing power of merchants in respect of MSFs and interchange.

For example, when weighted by volume, a 2012 survey of merchants

found that

around 85 per cent accepted Visa or MasterCard credit cards. Nevertheless, nearly 50

per cent did not accept American Express, and more than 60 per cent did not accept

Diners Club.

162. Because schemes still impose honour-all-cards rules (see Annex 2), merchants who

accept a scheme’s credit cards are not allowed to steer customers away from high-cost

cards, towards low-cost credit cards.

163. Merchants also steer by not accepting contactless debit. Our understanding is that only

around 30 per cent of merchants accept contactless payment, although this is growing,

and likely to be significantly higher when weighted by volume.

3.2.6 Scheme relationship with banks (as issuers and acquirers)

164. While schemes do not see any revenue from interchange, they instead receive revenue

from issuers and acquirers for the use of scheme debit and credit cards. The exact

business model underlying the flows, and the value of these flows, is not public.

Nevertheless, our understanding is that:

• Issuers pay schemes a service fee in proportion to the number and value of

transactions that take place on their cards.

• In some instances issuers receive a rebate from a scheme, for example, if they solely

offer that scheme’s products, or undertake programmes that increase the volume of

transactions that are processed on that scheme’s rails.

• Issuers receive a rebate from a scheme if they increase the volume of transactions

that are processed on a scheme’s cards.

• Acquirers pay a fixed scheme processing fee per transaction and a fee based on the

value of transactions they process.

According to figures from IKEA, the introduction of surcharging for credit in the UK simply led to a

near one-for-one replacement of credit transactions with debit transactions. See Symons, C. (2012).

Submission to Canadian Competition Tribunal. Retrieved from

http://www.ct-tc.gc.ca/CMFiles/CT-2010-

010_Witness%20Statement%20of%20Charles%20Symons_229_45_3-13-2012_6999.pdf

Commerce Commission (2013). Evaluation of the 2009 interchange and credit card settlements.

MINISTRY OF BUSINESS, INNOVATION & EMPLOYMENT

Retail Payment Systems in New Zealand: Issues Paper

165. The monetary flows between schemes, issuers and acquirers therefore mean that both

schemes and issuers have incentives to increase card usage so that more revenue can be

collected. Nevertheless, in theory, competition in these markets should constrain the

per-transaction revenues of the schemes, at least from issuers. This is because issuers

have a choice over which scheme’s products they offer. Of the five major banks, just two

(ANZ and BNZ) offer both Visa and MasterCard credit cards, while none offer both Visa

and MasterCard debit cards. Therefore, if scheme fees to issuers were to increase,

issuers could threaten to only offer the other scheme’s products.

166. There may be less competitive pressure in the scheme-acquirer market. This is because,

since the 1990s, in order to attract merchants, all banks have acquired transactions from

both schemes.

Therefore, any threat to not acquire a scheme’s transactions following

an increase in scheme fees may have limited credibility. Nevertheless, schemes are likely

to face some limit in their ability to profitably raise their fees to acquirers. This is

because, assuming these costs are a passed on to merchants, any increase in the MSF

will have a (possibly small) negative effect on merchant acceptance.

Ancillary relationships 3.3

3.3.1 Switch relationships with banks (as issuers and acquirers)

167. As noted above, most transactions are ‘switched’ by either Paymark or Verifone New

Zealand. Both charge a per-transaction fee to either the issuer (for switch-to-issuer

transactions) or acquirer (for switch-to-acquirer transactions). Verifone’s switch was

initially operated by ANZ (branded as EFTPOS NZ), before being sold to Verifone in 2013.

Currently Verifone is only able to process transactions where the merchant’s acquirer is

ANZ, although Verifone is trying to gain access to process transactions for merchants

who acquire with BNZ, Westpac and ASB. Schemes also have the ability to process some

transactions directly, bypassing a switch, but we understand that the vast majority of

transactions still pass through a domestic switch.

168. There are a number of entities, known as payment gateways, that complement or

substitute for Paymark and Verifone for card-not-present transactions. In New Zealand,

Payment Express handles many web-based transactions. Other competitors include

Paymark’s Click service, Paystation, and Swipe. In addition to online payments, these

systems also facilitate manual (e.g. mail order) processing of credit card payments. For

online payments, these switches also act as the customer interface.

3.3.2 Switch-merchant relationships

169. Merchants also face a nominal fee to be connected to a switch, regardless of payment

types or volumes. This connection is required for the merchant to accept any type of

electronic card. For example, Paymark charges $13.50 a month per terminal, capped at

five terminals per store. Competition over these charges is likely to be similar to

competition in the switch-issuer and switch-acquirer markets. We do not consider this

flow to be central to the system and therefore do not discuss it further.

3.3.3 Merchant-terminal provider relationships

170. In addition to the MSFs that merchants pay to acquirers, merchants with a physical

presence also face separate costs for using the physical payment hardware that provides

a customer interface. These terminals are required regardless of which payment cards

the merchant chooses to accept. Merchants may either purchase a terminal (for in the

Prior to this, merchants may have needed to have a relationship with multiple acquiring banks if they

wanted to accept cards processed by both schemes.

MINISTRY OF BUSINESS, INNOVATION & EMPLOYMENT

Retail Payment Systems in New Zealand: Issues Paper

region of $1,000) or hire a terminal for a monthly fee. In some cases, merchants have

the option of paying a per-transaction fee to the terminal provider in return for a lower

monthly rate. There are, anecdotally, at least 80 terminal providers in New Zealand.

171. Payments New Zealand requires all terminals to comply with various security standards.

This means that merchants are required to replace their terminals every few years.

Some of the stakeholders we spoke argued that the requirement to upgrade terminals

was an unnecessary additional cost for merchants. However, the cost of terminals seems

to be a relatively small component of retail payment systems as a whole.

Resource costs 3.4

172. This section has examined the fees and inducements that support the business models

of retail payment systems. It has not, however, outlined the underlying costs that

different participants face – regardless of whether there is an explicit fee or charge –

associated with a particular method of payment. To do so is difficult because most of

the data required to determine this is not public, and no work has been done to

estimate these costs in New Zealand.

173. Nevertheless, staff at the Reserve Bank of Australia

(RBA) have attempted to calculate

the ‘resource cost’ of various methods of payment – that is, the economic resources

expended by the various system participants to ‘produce’ a payment. This includes

factors such as fraud prevention, authorisation and transaction processing, tender time

at the point of sale, and other back-office costs. Crucially, this measure does not account

for transfers between parties, such as rewards or merchant service fees. While these are

private benefits and costs, they are not a cost to the system as a whole.

Figure 10: Australian resource costs by transaction value (RBA data, Australian

dollars)

Stewart et al (2014). The Evolution of Payment Costs in Australia. Retrieved from:

http://www.rba.gov.au/publications/rdp/2014/pdf/rdp2014-14.pdf

$0.00

$0.10

$0.20

$0.30

$0.40

$0.50

$0.60

$0.70

$0.80

$0.90

$1.00

$0 $20 $40 $60 $80 $100

Credit cards (inserted/swiped) Credit cards (contactless)

Scheme debit (inserted/swiped) Scheme debit (contactless)

Proprietary EFTPOS Cash (high estimate)

Cash (low estimate)

Average NZ electronic transaction size ($AU)

MINISTRY OF BUSINESS, INNOVATION & EMPLOYMENT

Retail Payment Systems in New Zealand: Issues Paper

174. Figure 10 shows the RBA staff’s estimates of resource costs for various payment

methods, and how they differ based on differing transaction values (some resource

costs are fixed, while others are variable with the transaction amount). Applying these

cost estimates to the average electronic transaction size in New Zealand in 2016 ($50 –

approximately AU$47), yields the following resource costs (converted into New Zealand

dollars):

• Cash: NZ$0.55 (1.1 per cent of transaction value).

• Australian EFTPOS: NZ$0.48 (0.96 per cent).

• Credit cards: NZ$0.81 (1.62 per cent).

• Contactless credit: NZ$0.70 (1.40 per cent).

• Scheme debit cards: NZ$0.76 (1.52 per cent).

• Contactless debit: NZ$0.63 (1.26 per cent).

175. The dashed lines in Figure 10 are for contactless transactions. The lower resource cost

for contactless cards is due to reduced tender time for the merchants at the point of

sale.

176. If we assume that New Zealand has a similar level of inherent resource costs to

Australia, this would suggest that the cost to process an average-sized ($50) electronic

transaction via credit card is around two-thirds higher than the cost of processing an

EFTPOS transaction. Based on current transaction volumes, we estimate that the total

resource costs of processing card payments to the New Zealand system is around $950

million annually.

177. In fact, there is reason to believe that the difference in cost between credit and our

EFTPOS system is actually greater. This is because, at the time the RBA’s study was

undertaken, Australia’s system relied on a relatively costly system of bilateral linkages

between banks. This is in contrast to New Zealand, and what is generally considered to

be our more efficient system of switching based around Paymark (and to a lesser extent

Verifone). We understand that Australia has since implemented a more efficient,

centralised EFTPOS system.

Is the resource cost data robust? Is the Australian data likely to over-state or under-state

the costs of running New Zealand payment systems?

This takes data provided to us by a switch about the volumes of different types of transactions and

multiplies them by the resource cost per average-sized transaction from the RBA study. This may

underestimate the resource cost in that we know that credit card transactions are, on average,

considerably larger than debit transactions and would therefore incur a higher resource cost than is

calculated based on the average overall transaction size. On the other hand, use of Australian data

about the cost of proprietary EFTPOS may overstate the resource cost of proprietary EFTPOS

transactions in New Zealand.

MINISTRY OF BUSINESS, INNOVATION & EMPLOYMENT

Retail Payment Systems in New Zealand: Issues Paper

4. Issues identified

Overview 4.1

178. We have identified a number of issues in both the credit and debit card markets. Many

of these issues result from the interchange business model operating in New Zealand.

179. We consider that there are two main issues in the credit card market, where the

interchange business model is resulting in:

• Issue 1: Economic inefficiency of $45 million dollars of additional cost annually as a

result of the induced usage of the relatively more expensive credit card network.

• Issue 2: Increased prices for all consumers (estimated at $187 million annually) to

fund credit card rewards, with mainly higher-income consumers benefiting from

those rewards.

180. The basis for these calculations is outlined in the remainder of this section, and in Annex

181. This is the result of the fact that consumers do not face accurate price signals, and leads

to overall higher costs for consumers. These issues are long-standing, although there is

some evidence that these inefficiencies have been growing in recent years as a result of

the premiumisation of credit cards.

182. Similar issues are developing in the debit market, where the interchange business model

is now competing with “free” debit transactions (EFTPOS and inserted or swiped scheme

debit).

• Issue 3: Given the dynamics of the interchange business model, the inefficiencies and

wealth transfers of the credit card market could also emerge in the debit market.

• Issue 4: There may be technical or institutional barriers to entry or expansion for new

debit payment products.

183. The size of the issues in the debit market is difficult to quantify at this stage. This is

because recent technological developments could allow for significant retail payments

innovation. The timing and scale of any new developments are difficult to predict.

184. The interchange business model is also impacting on small and medium enterprises

(SMEs) in both markets:

• Issue 5: The gap between merchant service fees paid by large (“strategic”) merchants

and others is significant and seemingly growing, reducing the competitiveness of

smaller businesses. The lack of pricing and cost transparency may be reducing the

ability of these businesses to negotiate better fees with acquiring banks and make

decisions about which payment options to accept and whether to surcharge.

MINISTRY OF BUSINESS, INNOVATION & EMPLOYMENT

Retail Payment Systems in New Zealand: Issues Paper

The interchange business model is resulting in inefficient 4.2

outcomes in the credit card market

4.2.1 Consumers do not face accurate price signals…

185. We consider that the incentives faced by all market participants – consumers,

merchants, issuers, acquirers and schemes – lead to a greater use of credit cards relative

to other payment options, compared to a situation in which these incentives did not

exist. Fundamentally, consumers’ choices between payment options are distorted by the

incentives placed on them by card issuers and merchants. This means that, in making

their decisions – while acting completely rationally and in their best interest at an

individual level – consumers do not face or take into account the system-wide costs and

benefits of various payment options.

186. As noted in Section 2.1, credit cards offer benefits to both consumers and merchants,

allowing consumers to spend when they do not have cash on hand and allowing

merchants to accept payment from a larger pool of potential customers (particularly

international consumers). We do not dispute this, and these benefits are justifiably

reflected in the existence of a price placed on merchants for credit card transactions.

The question explored in the remainder of this section is whether the incentives in the

system distort this price beyond what is efficient.

187. Ordinarily, it is not the role of government to second-guess how consumers choose to

spend. In general, we assume that transactions only take place if both the buyer and the

seller consider themselves to benefit from the transaction. We also generally assume

that this decision is made in the absence of significant externalities, and therefore the

private costs and benefits to the consumer are close to the system-wide costs and

benefits.

188. This is not the case when a consumer selects a payment option. Due to the flow of

interchange, in many cases consumers do not face anywhere near the full cost of their

payment choice. This is because, as discussed in Section 3:

• More than 70 per cent of credit card spend now earns rewards, and a growing

proportion of credit cards are ‘premium’ cards, which attract a higher interchange

rate and MSF. These rewards can be a significant incentive to use a particular card, in

addition to other financial benefits provided to credit card users, such as an interest-

free period.

• These rewards are substantially funded through interchange, rather than annual

fees. This means that the cost of using a credit card can be negative for a cardholder.

That is, many credit card holders are effectively paid to use their card.

• Few merchants surcharge, meaning that the costs a merchant faces in accepting

payment are averaged out across all consumers.

189. The lack of price signals to cardholders is a problem because it leads to:

• Higher costs for processing retail transactions than would likely be the case if clear

price signals did exist (and consumers responded to these signals).

• A redistribution of wealth from users of low-cost payment methods to those who

receive rewards.

• Higher overall costs of goods and services as a result of the costs merchants face in

accepting payment.

MINISTRY OF BUSINESS, INNOVATION & EMPLOYMENT

Retail Payment Systems in New Zealand: Issues Paper

190. The overall process is referred to in the economic literature as “price coherence and

adverse intermediation”

. In such markets, intermediaries (schemes and banks) can

charge fees to merchants to incentivise consumers (through rewards) to use their

service (credit cards). Cardholders then switch to using higher-cost cards, with increased

costs ultimately borne by all consumers. This system works because the financial

incentives to cardholders are large enough to effectively motivate their choice of

payment option. These financial incentives are funded by a wider base (all consumers)

through slightly higher overall prices on all goods which are difficult to detect (and

therefore do not influence cardholders decisions).

4.2.2 …which results in higher costs to process retail transactions…

191. As noted in Section 3.4, the RBA found that the resource cost of a scheme credit card

transaction is roughly two-thirds higher than the cost of an EFTPOS transaction,

excluding the cost of credit and rewards. If we assume that New Zealand has a similar

ratio of costs between payment methods to Australia, we estimate that the use of credit

cards instead of proprietary EFTPOS adds $137 million in costs to the New Zealand

economy annually.

Even though it is not borne by consumers in direct costs, these

costs will be passed onto consumers in higher overall prices.

192. It could be argued that this outcome is efficient by default because it is the result of

market participants’ decisions. However, we know from Section 3.2.2 that a high

proportion of consumers pay their credit card account balance before it attracts any

interest, and that around 40 per cent choose credit cards primarily for the rewards they

attract. For these rewards-focused consumers, credit card transactions are not made for

the credit itself, which might justify the greater resource cost to the system; rather, the

credit option is used to attract the financial benefit attached to using the premium card.

Extra resource cost is incurred in putting through these credit card transactions, with no

overall benefit to the economy, just a transfer of rewards to the individual consumer.

Therefore, a conservative estimate of the added cost to the economy that arises from

the use of credit cards by this 40 per cent is $45 million annually.

193. Put another way, 40 per cent of credit card users have no need for the credit; they have

sufficient funds in their accounts to pay for the purchases. However, they use their cards

because they are incentivised to do so through rewards and do not face the full cost of

doing so, since surcharging is uncommon. This individually rational behaviour then leads

to system-wide inefficiencies.

Do you agree with the logic underpinning our assessment that there is inefficiency in the

credit card market?

Edelman and Wright. (2014). Price coherence and adverse intermediation. Retrieved from

http://www.hbs.edu/faculty/Publication%20Files/14-052_41d72e17-7ca8-4090-99eb-a7d24e8eaa0f.pdf

This is distinct from the estimated $461-589 million in MSFs that merchants face to accept payment.

MSFs can exceed resource costs in some instances, as resource costs ignore transfers (most notably

rewards) and profit margins, while in the case of proprietary EFTPOS, the resource cost exceeds the

(zero) MSF.

We assume that around 20% of credit card transactions are made by business or international

cardholders, and have removed these from the analysis on the basis these transactions are unlikely to

have been induced by rewards. The $45 million represents around 0.13 per cent of the total value of

expenditure on credit cards in the year to March 2016.

MINISTRY OF BUSINESS, INNOVATION & EMPLOYMENT

Retail Payment Systems in New Zealand: Issues Paper

4.2.3 …and higher overall prices for consumers…

194. Competition between issuers for consumers through rewards programmes results in

upwards pressure on interchange fees paid by merchants, which are in turn passed onto

all consumers as higher prices for all goods and services. We estimate that the presence

of credit card rewards increase prices of goods and services for consumers by $187

million per annum. This is just a portion of the fees paid by merchants.

195. Higher prices are faced by all consumers, as a result of the low prevalence of surcharging

by merchants. If surcharging occurred, merchants would not have to factor the cost of

electronic transactions into the general prices because they would be recovered directly

from each customer depending on payment method used in each case.

4.2.4 …although these higher prices can be partially or fully offset for consumers

who receive credit card rewards

196. The increase in costs faced by consumers can be offset for the holders of rewards-

offering credit cards, who in some cases may receive rewards that greatly exceed the

overall increase in price that they face. On the other hand, those who do not hold

rewards-offering credit cards face an increase in price, with no corresponding benefit.

This represents a wealth transfer from the users of low-cost payment options to users of

high-cost cards.

197. This wealth transfer is strongly regressive. This is because users of high-cost credit cards

are likely to be on high incomes due either to issuer rules (for example, the Air New

Zealand American Express Platinum Card has a minimum income requirement of

$65,000), or self-selection as a result of higher-annual fees (that nevertheless do not

cover the full cost of rewards). In contrast, the cost that merchants face is passed on to

all consumers, including those on low incomes. Our rough estimate is that this results in

an ongoing cross-subsidy from low-income households to high-income households of

$59 million per annum.

Do you agree with the logic underpinning our assessment that reward schemes result in

higher overall prices and cross-subsidies?

Box 2: Are payment system cross-subsidies worse than any other cross-subsidy?

A repeated theme in our discussion with stakeholders was that, while credit card rewards

likely result in a cross-subsidy from users of low-cost cards to users of high-cost cards, there

are a range of cross-subsidies that exist across the economy. Stakeholders argued that cross-

subsidies that occur in retail payments are fundamentally no different to those that might

exist in respect of loyalty schemes (such as FlyBuys), petrol rebates, free car parking, or the

cost of labour on weekends.

We agree that cross-subsidies are prevalent across the economy. While cross-subsidies may

be allocatively inefficient, they can be valued by consumers, and are clearly profit-enhancing

In arriving at this figure, we assume that 10% of credit card transactions are made by international

cardholders, and remove them from the analysis. We include business cardholders in the analysis. We

assume that 75% of credit card spending attracts rewards, that the average value of rewards is 1% of

expenditure, that 20% of rewards are funded through annual fees, that only the highest-earning 40% of

households earn rewards, and that these households are responsible for 68% of retail expenditure. The

$59 million figure represents around 0.17 per cent of the total value of expenditure on credit cards in

the year to March 2016.

MINISTRY OF BUSINESS, INNOVATION & EMPLOYMENT

Retail Payment Systems in New Zealand: Issues Paper

for firms that introduce them. Nevertheless, it is not uncommon for firms to seek to

minimise them. For example, surcharging on public holidays is becoming more common.

Cross-subsidies associated with credit card rewards can be distinguished from other cross-

subsidies in two main ways:

• Firstly, card payments are pervasive across the economy in a way that few, if any,

other cross-subsidies are. Individual businesses may offer free car parking to their

consumers, or pay staff more to work on weekends without surcharging. However,

the cross-subsidy in relation to card payments essentially extends to any merchant

who accepts a credit card payment.

• Secondly, when businesses cross-subsidise a product or service, they generally make

an active decision to do so. For example, a business that decides to offer FlyBuys

does so knowing that it will have to charge extra to all of its customers to pay for the

benefits that those who utilise the reward scheme receive. In contrast, a merchant

is not a participant in the decision-making around the cost of rewards that are

embedded in their MSF. Therefore, because rewards are tied to the payment

method, a merchant cannot choose to accept credit card payments without also

accepting the higher-cost cards that also provide rewards.

4.2.5 These issues are unlikely be resolved by market mechanisms

198. There are several ways that the lack of price signals could theoretically be resolved

through market mechanisms. One way is through increased surcharging for expensive

payment methods by merchants. However, as alluded to in Section 3.2.6, merchants in a

competitive market face a significant first-mover disadvantage through a negative

customer reaction if they introduce surcharges, making it unlikely that surcharging will

become significantly more widespread. Box 3 explores the possibility of surcharging

further.

Box 3: Is surcharging the solution?

Accurate surcharging for the use of higher-cost payment options would reduce the impact of

premium card rewards. This is because a surcharge at every purchase would negate any

benefit that would accrue to the premium card holder over and above what is the intrinsic

value of using that payment option. A consumer would only choose to use a payment option

that attracted a surcharge if they valued the benefits (such as the credit or contactless

function) more than the cost.

However, Section 3.2.5 outlined that merchants face technical and customer experience

barriers to surcharging. There are also challenges in accurate pricing in the first place. This is

because merchants do not face prices for each payment option on the same basis. In New

Zealand, acquiring banks charge merchants for costs associated with credit transactions and

contactless scheme debit transactions, but not for EFTPOS or contacted scheme debit

transactions. Nor do merchants face all of the costs associated with cash. This means that

any menu of surcharges based on these costs would not send accurate price signals to

consumers; they would act as rough proxies at best.

The use of discounts is a possible alternative to surcharging. While theoretically equivalent,

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Retail Payment Systems in New Zealand: Issues Paper

and psychologically more acceptable to consumers, discounting is potentially less effective

at influencing behaviour

, can make merchants’ headline prices look less competitive than

those who don’t discount, and presents similar implementation issues to surcharging.

199. Another way of providing consumers with accurate price signals would be for issuers to

increase annual fees to more closely reflect the benefit received by cardholders.

However, in a (seemingly) competitive market between issuers for consumers, there is

little incentive to do so when it would discourage consumers from choosing their

product, and when there is already a substantial flow of income from interchange to

fund rewards.

This means that we see it as highly unlikely that unilateral action by

issuers will correct the price signals to consumers in the foreseeable future.

200. If the inaccurate price signals cannot be corrected for directly, the extent of the

inaccuracy could at least be reduced if merchants or acquirers had greater ability to

negotiate down interchange and MSFs. Section 3.2.3 outlined the reasons why acquirers

that form part of issuing banks have limited incentive to negotiate down interchange

rates. In addition, Box 4 explores the reasons that self-acquirers are also unlikely to act

as a countervailing force on interchange.

Box 4: Will self-acquirers place downward pressure on interchange?

The Commission’s 2009 settlement (see Annex 2) allowed for entities to become acquirers

of card transactions without also being card issuers or financial institutions. In theory, this

has the potential to place downward pressure on interchange fees, because self-acquirers

are likely to be significantly more averse to an increase in interchange fees than combined

issuer-acquirers (see Section 3.2.3).

In practice, it is unlikely that the provision for self-acquiring has had any material impact on

interchange rates. We are only aware of one merchant that self-acquires in New Zealand:

Countdown. It informed us that becoming a self-acquirer required a substantial investment

that was only viable due to two reasons. Firstly, Countdown had the ability to leverage off

infrastructure developed by its parent company, Woolworths Australia. Secondly, self-

acquirers formerly faced a significant financial advantage in terms of lower scheme fees on

transactions that self-acquirers routed directly to an issuer (“on-us”) as opposed to the

scheme fees associated with the traditional flow of transactions via an acquirer (“off-us”).

However, shortly after Countdown began acting as a self-acquirer, changes were made by a

scheme to remove any pricing differential between on-us and off-us credit transactions,

largely eliminating the financial advantage associated with self-acquiring.

While Countdown noted that being a self-acquirer has given it the benefit of being able to

directly negotiate with issuers in respect of interchange, it stated that, given the current

pricing structure, it may not have made the decision to self-acquire. Countdown also noted

that in the absence of any regulated access rules, not all issuers have agreed to participate

in Countdown's self-acquiring model. The investment required to become a self-acquirer,

combined with the new pricing structure of one of the schemes and the lack of stipulated

See, for example, Canadian Competition Tribunal. (2012). Closing Submissions of the Commissioner of

Competition in the matter certain agreements or arrangements implemented or enforced by Visa

Canada Corporation and MasterCard International Incorporated. Retrieved from

http://www.ct-

tc.gc.ca/CMFiles/CT-2010-010_Closing%20Argument%20of%20the%20Commissioner%20of%20

Competition_303_45_7-5-2012_6244.pdf

In addition, annual fees are a fixed revenue source, whereas rewards are variable depending on

spend, so there would be inefficiencies associated with the use of greater annual fees to fund rewards.

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Retail Payment Systems in New Zealand: Issues Paper

access rules, has had the effect of making it appear highly unlikely that any other self-

acquirers will enter the New Zealand market. This means that issuers and schemes are

unlikely to face any real pressure to reduce interchange rates and caps via this mechanism.

Do you agree that self-acquirers are unlikely to place downward pressure on

interchange?

201. Section 3.2.4 noted that merchants do have some ability to negotiate down the MSF

they face, but pointed out that this ability to negotiate is largely limited to negotiating

over the extent of the acquirer’s mark-up over the interchange rate. In addition, large

merchants are able to place some downward pressure on the interchange rates they

face. However, these efforts to date have not been large enough to make an appreciable

difference to the overall price incentives faced by consumers. We do not foresee any

market developments in the near future that would substantially increase merchants’

ability to negotiate down MSFs or interchange on credit cards, and in doing so, reduce

the level of distortion of price signals that currently exists.

202. This is because, as long as credit card rewards exist at their current rates, many

consumers will not see other payment methods (such as debit cards or direct entry

payment methods) as direct substitutes. In fact, the recent growth in rewards, to the

extent that it is sustained, will serve to widen the distinction between credit cards and

other forms of payment that do not attract rewards. The less that other payment

products are seen as competitive substitutes to credit, the more consumers will demand

the ability to pay with credit, and the less bargaining power a merchant will have over

MSFs. We think that this dynamic, combined with the migration of consumers to cards

that attract higher interchange, may explain the recent rise in MSFs for small and

medium-size merchants.

203. As long as merchants feel compelled to accept credit card payments (due to consumer

demand), the schemes will face little incentive to reduce interchange caps, because to

do so would make other schemes’ products more attractive to issuers and, in turn,

consumers. For the same reasons, there is little reason to believe that issuers will

unilaterally choose to reduce the interchange they charge within these caps when doing

so would harm their ability to attract consumers.

How much negotiating power do merchants have over the merchant service fees they

face? Is this likely to change in the future?

4.2.6 This is a long-standing economic distortion that is growing

204. The issues relating to high-cost credit card payments, allocative inefficiency, and cross-

subsidies in relation to credit card transactions are long-standing. Long-run weighted

average interchange rates for credit card transactions fluctuate, with some recent

growth, but are not rising sharply. Similarly, as noted in Section 3.2.2, the value of

rewards for New Zealand credit cards appears to have remained reasonably consistent

until last year, when rewards grew (and many annual fees were waived) following the

renegotiation of the Air New Zealand Airpoints programme with banks.

205. Even at their current level, we think that the issues described here represent an

unnecessary economic distortion that there is merit in addressing. These issues are

largely independent of the investment and innovation in credit card products – that is,

reducing the level of inefficiency in the market should not have a negative impact on

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Retail Payment Systems in New Zealand: Issues Paper

innovation. Moreover, there is also evidence that the overall level of distortion is

increasing. As noted in Section 3.2.2, we know that there has been an overall

premiumisation of cards of late, with more cards attracting higher rewards, interchange,

and MSFs, and therefore potentially increasing allocative inefficiency and cross-subsidies

above the estimates provided in this section.

Do you think that the issues in the credit card market are of a scale that warrants

intervention? If not, do you think that the size of the issue is likely to grow over time?

4.2.7 Summary

206. In summary, the current inducements to use credit cards substantially distort price

signals which result in a greater use of economic resources to process retail payments

and a cross-subsidy from users of low-cost payment methods to high-cost users. It

appears unlikely that this dynamic will be resolved by market mechanisms in the

foreseeable future – in fact the dynamics inherent in the market may actually serve to

exacerbate this issue over time – meaning that government intervention may be

required to resolve this issue.

Inefficiencies could develop in the debit market 4.3

4.3.1 The growth of scheme-based debit payments creates cause for concern…

207. In addition to the issues in the credit market, the debit market could also be heading in a

direction that would not deliver good overall outcomes for consumers. As Figures 3 and

4 demonstrate, the debit market is currently dominated by transactions that are

switched to issuer (proprietary EFTPOS and inserted/swiped scheme debit), although the

use of switch-to-acquirer and the associated interchange business model is growing

rapidly as a result of the growth of contactless and online transactions.

208. The share of contactless transactions will continue to grow as more merchants start

accepting contactless debit payment. We predict that the share of card-present

transactions made contactlessly could increase to at least 60 per cent of all debit

transactions by 2024 (compared to around 15 per cent currently, and around 2 per cent

in January 2014).

However, ultimately, the level of growth will depend on the following

interrelated factors:

• The financial incentives for use set by schemes, issuers, and acquirers.

• The level of pressure from consumers for contactless payment.

• The extent of growth of online purchases.

• The development of technology that encourages contactless payment, such as

mobile apps.

• The levels of merchant acceptance.

209. There are real benefits associated with contactless technology for both consumers and

merchants. However, because of the commercial model that underpins it, the growth of

contactless transactions creates cause for concern due to:

We consider this to be reasonably conservative, assuming steady growth in merchant acceptance. For

example, liner modelling based on current trends would actually place contactless debit usage at more

than 70 per cent of all debit transactions by 2024.

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• The potential for schemes, issuers and acquirers to increase interchange and MSFs as

contactless payment becomes entrenched and price sensitivities of consumers and

merchants change.

• The potential for cross-subsidies and a negative impact on allocative efficiency, as

with the use of credit cards.

• The possibility that the schemes’ interchange business model limits uptake of cheap

or innovative payment options by consumers.

4.3.2 …and many participants face incentives to encourage its uptake…

210. Many participants face an incentive to encourage the uptake of contactless payment.

Firstly, it is in the interests of schemes to increase the volume of contactless

transactions. This is because the schemes receive revenue from issuers and acquirers

when transactions are processed via switch-to-acquirer, as contactless is. In doing so,

the schemes are competing with each other’s products, as well as with proprietary

EFTPOS (and other payment methods). Thus, in order to grow consumer usage, the

schemes need to balance the interchange cap set to ensure that issuers are incentivised

to issue their product to consumers over proprietary EFTPOS, while ensuring that

charges to acquirers (and then merchants) do not harm (and promote) the acceptance

of contactless products.

211. Secondly, it is also in the interests of issuers to increase the volume of contactless

transactions. This is because they receive revenue from the associated interchange fee.

Issuing banks receive no such revenue from proprietary EFTPOS or swiped/inserted

scheme debit transactions. In fact, these latter transactions cost banks (see below).

Issuers are also responding to consumer demand for scheme debit cards on the basis of

their greater functionality (i.e. they can be used internationally and online). While many

of the transactions that take place on these scheme cards will not attract a revenue

source immediately, they know that the percentage of revenue-earning transactions will

increase quickly as contactless uptake increases.

212. We also expect that consumer pressure for contactless acceptance will continue to

grow. This pressure is completely rational from the perspective of an individual

consumer. Contactless payment is more convenient for the consumer, and as with credit

cards (see Section 4.2 above), consumers do not face the direct costs of this added

convenience. The time saving provided by contactless payment is marginal (though

proportionately more important in short-interaction contexts such as bars or fast-food).

Nevertheless, contactless payment does offer a better customer experience. While

subtle, many merchants are likely to be conscious of the negative impression a customer

receives when they expect to be able to pay contactlessly only to find that they cannot.

213. Finally, the merchant’s decision whether to accept contactless payment depends on

whether they consider the additional cost to justify the benefits that accrue to them. In

this case, relevant factors may include:

• Whether acceptance of contactless payment would increase sales.

• Whether the time saving that results from the use of contactless payment is valuable

in the context of the merchant’s business model.

• If contactless payment displaces another payment option, the cost or saving of that

incremental change. For example, shifts from proprietary EFTPOS and

inserted/swiped scheme debit and cash to contactless debit payment will cost the

merchant, but shifts from credit card to contactless debit will save the merchant

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money. It seems likely, however, that the former shifts involving added cost (from

EFTPOS and cash) will outweigh the latter shift involving savings (from credit).

214. In addition, as more merchants accept contactless payment, the remaining merchants

will face increasing competitive pressure to also do so. This is being driven by larger,

“strategic” merchants taking up contactless payment, partly in response to bank and

scheme incentives, including significantly lower interchange rates compared to smaller

merchants and rebates directly from the schemes. This pressure to accept contactless

payment arises because consumers more frequently shop at strategic merchants (such

as supermarkets) and come to expect this option when they shop elsewhere.

Do you agree with our assessment of the incentives held by different parties in relation

to debit card usage?

4.3.3 …but there is little incentive to invest in proprietary EFTPOS

215. Just as dial-up internet was long left behind as a competitor to broadband, proprietary

EFTPOS is quickly reaching the stage where its limited functionality (and security) means

that it is no longer an effective competitor to scheme cards. This lack of innovation is

largely due to the incentives on the banks that have evolved as the EFTPOS system

developed. There is no “owner” of proprietary EFTPOS – it is not a scheme that seeks to

compete for market share. At present, the banks:

• Own Paymark, the switch that processes around three-quarters of electronic

transactions (the remainder are largely processed by Verifone, formerly owned by

ANZ).

• Have a majority on the Board of Payments New Zealand and on its Consumer

Electronic Clearing System committee.

• Are card issuers, providing EFTPOS and scheme debit cards to consumers.

216. As it stands, Paymark’s main business is to act as a switch for transactions. From the

outside, it appears that its shareholders have little incentive to support or fund other

activities, such as the development of online EFTPOS or greater functionality of non-

scheme payment cards. This is because issuing banks do not receive a revenue stream

from proprietary EFTPOS transactions, and therefore directly carry the cost of

processing the EFTPOS transactions made by the cards they issue. Any investment in

Paymark therefore represents a direct cost to the banks.

217. Payments New Zealand had previously undertaken work to explore adding greater

functionality to proprietary EFTPOS, but has largely abandoned this work due to

conflicting interests among its shareholders, directors and participants.

218. On the other hand, as already discussed, issuers of scheme debit cards receive

interchange revenue each time the scheme debit card is used contactlessly. As it stands,

this makes contactless scheme debit products sufficiently attractive to justify not

investing in the upgrades to the proprietary EFTPOS scheme that would be required to

make it a viable competitor.

14 Do you agree that there is little incentive to invest in proprietary EFTPOS?

4.3.4 Merchants will face an increase in costs …

219. The “free”-to-merchant proprietary EFTPOS business model that has prevailed in New

Zealand for nearly 30 years has had the effect of making it effectively unviable to charge

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Retail Payment Systems in New Zealand: Issues Paper

merchants for inserted or swiped scheme debit transactions. When scheme debit was

introduced, the schemes and issuers understood that doing so would substantially limit

acceptance by merchants when, in the card-present context, proprietary EFTPOS and

scheme debit are substantively equivalent. It is only the introduction of contactless

debit, arguably an added service at the point of sale, which allowed the schemes and

banks to introduce the interchange business model to mainstream debit transactions

when it was previously confined to online and international debit transactions.

Box 5: Will schemes start imposing interchange on swiped/inserted scheme debit?

One of the concerns aired by merchants is that once scheme debit products are sufficiently

embedded in the New Zealand market, schemes could start switching these transactions to

acquirers and apply interchange, increasing costs for merchants. In our discussions with

them, schemes have been adamant that they will not introduce interchange on scheme

debit. If they were to do so, they argue that many merchants would either stop accepting

their cards or surcharge, and that many consumers would move back to proprietary EFTPOS.

This appears to be the case. Given the relatively rapid increase in contactless payment, there

is little need for the schemes and issuers to risk reducing acceptance of their product by

applying interchange when revenues are already rising relatively rapidly through the

increased use of contactless debit.

Nevertheless, there are scenarios – such as if banks were to stop issuing proprietary EFTPOS

cards and thereby remove this payment method as a competitive constraint – that it could

be advantageous to schemes and issuers to start applying interchange. For this reason, it

may be beneficial for schemes and issuers to make their intentions clear to the market.

Do you agree that it is unlikely that schemes will start imposing interchange on

swiped/inserted scheme debit transactions?

220. An immediate impact of proprietary EFTPOS gradually losing market share to contactless

scheme debit is an increase in the overall cost to merchants for transactions to be

processed. This increase in cost is not tied to the contactless technology, but to the

interchange business model that it utilises. Based on current uptake, the cost to

merchants of accepting contactless debit was likely around $36 million in the 12 months

to March 2016.

If 60 per cent of card-present debit payments were made

contactlessly, the annual cost to merchants of accepting contactless debit could

increase to $252 million.

221. This projection assumes no change to the contactless interchange fee or MSFs charged

by acquiring banks. In fact, in the short-term, it seems plausible that interchange and

associated MSFs on contactless debit may fall further in order to drive greater

acceptance. Costs to merchants will nevertheless increase over time as a greater

proportion of payments attract MSFs. As with credit card interchange, the relative

Based on switch data and Retail NZ MSF estimations. The $36 million estimate uses different MSF

assumptions to the $461 million estimate of total MSFs in Section 3.2.4, but it conceptually forms part of

the $461 million total (rather than being on top of it). The $36 million does not include the cost of card-

not-present debit payments (which are captured in the data as credit transactions).

Based on MBIE uptake modelling and Retail NZ MSF estimations. This figure assumes no change to

MSFs, retail sales, or electronic transactions as a proportion of total retail sales. It does not include the

cost of card-not-present debit payments.

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burden of the cost increases will be more severe for smaller merchants, given the higher

MSFs they face on average.

222. Merchants are, as would be expected, concerned about the increase in cost to their

business that they will face as a result of accepting contactless payment. However, we

do not, in itself, see this as a problem (see Box 6).

Box 6: The impact of “free” EFTPOS on innovation

The discussion about how the interchange business model will drive outcomes in the debit

payment market should not be read as an endorsement of the “free” pricing of proprietary

EFTPOS. Domestic EFTPOS was the most efficient debit payment option for a long time,

particularly compared to the main contenders at the time (cash and cheques). Given how

advanced the system was at the time it was introduced, there was limited gain in

investment to develop successor systems.

However, what was essentially the ‘under-pricing’ of EFTPOS created significant barriers to

enter the debit payment market. It also meant that the system received only the bare-

minimum level of investment, with few improvements to security or functionality over the

last 30 years, despite improving technology and increasing consumer expectations. Overall,

the legacy of the “free” pricing strategy is the inability of domestic EFTPOS to compete with

scheme debit.

Do you agree that merchants facing a per-transaction charge for accepting debit

payments is not an issue in itself?

4.3.5 …but the system-wide efficiency implications are less clear

223. Arguably more relevant to the efficiency of the system as a whole is the increase in

resource costs arising from the shift from proprietary EFTPOS to contactless debit. Using

the RBA’s resource cost data, the increase in resource cost to the system for each

average-sized transaction will be around 14 cents. At 60 per cent contactless uptake, we

estimate that the increase in resource cost to the economy arising from the use of

contactless payment instead of proprietary EFTPOS would be $97 million annually.

224. It should be noted that this comparison of resource cost relates to the cost of running

the systems as they stand. They do not address questions of price, or the level of

investment that would be required to support innovation and the development of

proprietary EFTPOS to a comparable standard to contactless debit.

This lack of

reinvestment is a key reason why the card schemes are now able to easily gain market

share, even though they are imposing an explicit cost for contactless debit transactions.

225. It is therefore not possible to make a strong judgement about the cost-effectiveness of

the shift towards scheme contactless debit, given the ongoing investment that would be

required to upgrade the proprietary EFTPOS system to allow it to compete with scheme

debit (again, assuming constant MSFs). In other words, while this short-term burden of

increasing costs associated with the shift to contactless payment will be directly borne

by merchants (and passed onto consumers through overall higher prices) it is not clear

This increase in cost is potentially conservative, given that it may overstate the cost of the New

Zealand proprietary EFTPOS system.

It has been suggested to us that the revenue required to maintain and invest in EFTPOS over time

would be a couple of additional cents per transaction.

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that the net increase in system costs (including scheme, issuer, acquirer, merchant and

consumer resource costs) is unreasonable given the sustained lack of investment in

proprietary EFTPOS.

Is the shift towards contactless debit cost-effective, taking into account the costs and

benefits to all parties in the system?

226. Even though it is inherently more costly to process a scheme contactless transaction

than an equivalent proprietary EFTPOS transaction, this would not be inefficient in itself

if the use of scheme products was the result of clear price signals to consumers.

However, this is not the case. As with credit cards, consumers do not face accurate price

signals when deciding to make a contactless transaction. This occurs at both ends of the

market. We know that surcharging is virtually non-existent for contactless payments,

and – at the fringes (such as Westpac’s AirPoints Debit MasterCard) – cardholders are

being subsidised to use contactless cards through interchange.

227. This means that the choice of which payment option to use will not be made by

consumers based on the relative costs of each option, as they will lack the relevant price

signals. The choice between payment options will instead be heavily influenced by

schemes, issuers and acquirers, based on the relative profitability of each payment

option, with these participants being able to determine the relative prices for consumers

and merchants. This includes the ability to require merchants to pay an interchange fee

(through their acquiring bank) to the card issuer. As with the credit market, the lack of

price signals can therefore be expected to lead to allocative inefficiency as the use of the

interchange business model in the debit market grows.

228. In addition, as with credit, there will also be a cross-subsidy associated with the use of

contactless debit, as merchants increase prices across the board. Given the lower

average MSF on contactless debit, the cross-subsidy will be lower than for credit,

although still non-trivial.

Do you agree that the lack of price signals in the debit market is likely to lead to

inefficient outcomes of a similar nature to those in the credit card market?

4.3.6 Increases in interchange fees and MSFs seem likely in the medium term

229. As with credit, schemes and banks (as issuers and acquirers) have significant scope to

compete for consumer volume, either by absorbing the cost (waiving card fees) or going

further by making the effective price of using their product negative, by offering rewards

or other inducements. This can be done by bidding up interchange fees, to allow card

issuers to compete for consumers, as long as merchants remain relatively insensitive to

price.

Having said this, there could also be a decrease in allocative efficiency as the use of proprietary

EFTPOS declines. If it is accepted that merchants should face a per-transaction cost from their bank for

accepting payment via proprietary EFTPOS (and not all stakeholders do), then the lack of price signals on

EFTPOS from the acquirer to the merchant creates a level of allocative inefficiency in itself. Therefore,

the overall impact on allocative efficiency depends on the net effect of a) a reduction in allocative

inefficiency as the number of transactions that are ‘under-priced’ to merchants by acquirers reduces;

and b) an increase in allocative inefficiency as the number of transactions that are ‘under-priced’ to

consumers by merchants increases.

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230. In addition to this outcome arising through an increase in competition within the

interchange model, it may also arise through a reduction in competitive pressure from

outside of the model (i.e. as proprietary EFTPOS and inserted/swiped scheme debit

usage reduces). There has been a recent decline in interchange caps for contactless

debit, as schemes work to increase acceptance of the contactless payment by

merchants. However, as consumers become more accustomed to paying with

contactless, the pressure on merchants to accept contactless payments will grow. As

with credit, this effectively means that merchants’ negotiating power with acquirers

(and acquirers’ negotiating power with issuers and schemes) will reduce.

231. Therefore, once a certain threshold of acceptance is reached, we think there is likely to

be an increase in the level of interchange (and MSFs) on contactless debit, entrenching

the allocative inefficiency and cross-subsidy issues discussed above, and ultimately

further increasing the prices paid for goods and services by consumers.

Do you agree that merchant service fees are likely to increase for contactless debit once

acceptance reaches a certain threshold?

4.3.7 New entrants will likely need to offer interchange revenue to issuers

232. A corollary of the dynamics that are facilitating the replacement of proprietary EFTPOS is

that any serious potential competitor to contactless payment will need to offer a

revenue stream to induce banks to issue their cards (or other payment mechanisms,

such as mobile payment applications). Aside from devising an exceptionally superior

product, any new entrant will have to offer a competitive income stream to issuing

banks to what they currently receive under the scheme model. This draws out a broader

point: the issuing bank will be a barrier to the uptake of any potential new payment

system as long as the bank is in control of access to the consumer’s bank account.

233. There are three caveats to this, in which a mainstream business model could be

developed without relying on the interchange business model:

• Firstly, banks may not always remain in control of the bank account. While banks

might resist third-party direct entry, there are already third party providers in the

card-not-present space – such as Poli – that utilise direct entry methods despite this

resistance.

• Secondly, consumers could hold secondary accounts with non-bank providers such as

PayPal themselves, mitigating the need for banks to provide access to a consumer’s

main account.

• Thirdly, banks might consider there to be strategic advantages from there being a

strong competitor to scheme products. This could include limiting the ability of

schemes to increase scheme fees, or attracting consumers from competing banks.

234. However, the likelihood of these three scenarios having a significant impact is limited by

the following factors:

• Issuers or non-bank payment providers are likely to require some level of revenue

from their product, as a strategic advantage is not useful if the business is not making

any money. There are seemingly a limited number of scenarios in which a consumer

would be willing to pay to use the product, given that existing mainstream card-

based products are largely free to use.

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• As noted in Section 3.1.2, it seems unlikely that many consumers would switch bank

or utilise a competing payment service on the basis of a superior debit product alone,

unless it was vastly superior.

• Relatedly, the network effects required to sustain an effective payment platform are

likely to be difficult to achieve – the withdrawal of Snapper in Wellington for store-

based payments is seemingly one example of this.

• This situation is different to the high cost of cash and cheques that motivated the

development of EFTPOS – even if the cost of debit scheme fees to the banks became

significant, banks wouldn’t necessarily have the incentive to build an alternative

together because there is a revenue flow associated with the interchange model that

there wasn’t with cash or cheques.

• Finally, even if there is an incentive for a particular bank to develop new products

that do not utilise an interchange model, they will still need to bilaterally negotiate

access to other banks’ systems to achieve a workable network. This could be difficult

to achieve.

Do you agree with our assessment that the interchange business model imposes

significant barriers to entry in the debit market?

4.3.8 A number of unknowns will affect how the market will develop

235. The upshot of the dynamics discussed above is that:

• Contactless debit payment, and the associated interchange model, is likely to

become pervasive in a relatively short timeframe.

• Competition within the interchange model will ultimately distort price signals and

increase overall prices of goods and services for consumers.

• There are significant impediments to the successful emergence of a mainstream

competitor that does not rely on the interchange model.

236. Nevertheless, unlike the credit market, where the issues discussed above have existed

for some time, there are a number of unknowns that make it uncertain how the debit

market will unfold. These include:

• The level of take-up of contactless payment through mobile phones such as Apple

Pay. Such payment options (which utilise scheme rails) are still in their infancy or

awaiting a New Zealand launch. If such payments gain popularity, and consumers

start expecting to be able to use their mobile wallets exclusively (leaving cash and

their payment cards behind), merchants will face greater pressure to accept

contactless payment.

• Whether new interchange-based payment options enter the market. While we have

recently seen the introduction of China UnionPay to the New Zealand market

(primarily for the benefit of Chinese tourists), the network effects of a payment

system make it difficult for new participants to gain traction. In any case, it is unclear

whether additional participants that utilise the existing business model would

actually improve outcomes, given the natural upward pressure on interchange.

• Whether non-interchange-based payment methods enter the market. As noted

above, barriers to entry are high, and new products would likely need to be a step-

change above the status quo if they are to gain traction. Nevertheless, it is possible

that payment options could be offered by existing businesses in other sectors, such

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Retail Payment Systems in New Zealand: Issues Paper

as social media platforms or other apps. Depending on the underlying rails, these

could utilise a significantly different business model, which could alter the dynamics

and outcomes of the overall market.

• Whether proprietary EFTPOS exits the market altogether. It has been suggested

that if the costs to banks of maintaining the proprietary EFTPOS system reach a point

where they exceed the benefits (for example, if levels of fraud on these cards start to

increase), banks could individually make the decision to stop issuing them. This could

reduce the competitive constraint on scheme debit fees paid to schemes, although

for this reason banks may be incentivised to keep proprietary EFTPOS around.

• Whether merchants start to steer and surcharge more. Greater use of these

techniques by merchants could lead to consumers using lower cost payment options.

Given the barriers discussed in Section 3.2.6, this seems unlikely, but could occur if

MSFs continue to increase.

21 How do you think the debit market is likely to evolve in respect of these ‘unknowns’?

4.3.9 Summary

237. While the exact outcomes in the debit market over the medium-term are far from

certain, the likely upshot of the dynamics discussed above is that contactless debit

payment, and the associated interchange model, is likely to become pervasive over a

relative short timeframe. Over time, competition between schemes and the

entrenchment of the interchange model may ultimately distort price signals and

increase overall prices of goods and services for consumers.

238. There is seemingly little prospect of the successful emergence of a competitor that does

not rely on the interchange model. This makes it unlikely that these emerging issues –

should they develop as expected – will be resolved by the market alone, meaning that

government intervention may be necessary in the future. As noted in Annex 1, Australia,

the United States, and the European Union have chosen to regulate interchange levels

for debit.

There is a large gap between the MSFs faced by small and large 4.4

merchants

239. The data provided to us by banks suggest that there is a large – and widening – spread in

the MSFs faced by merchants of different sizes, with interchange rates for small

merchants being around two and a half times the rate of the interchange rates for large,

‘strategic’, merchants. This spread of costs means that smaller merchants face a

competitive disadvantage with their customers relative to large merchants.

240. However, discussions with industry suggest that, while the gap between large and small

merchants has increased, it has not increased to the extent that the data suggests. This

is because, prior to the expiry of the Commerce Commission’s settlement, large

merchants received significant rebates from acquirers that weren’t captured in these

figures. Following the expiry of the settlement, these rebates were reduced, and large

merchants went directly to the schemes to negotiate reductions in the headline

interchange rate that they faced.

241. Differences in bargaining power (and thus cost faced) between small and large

merchants are pervasive across a number of industries. As one example, major users of

electricity face much lower energy tariffs than households and small businesses. Often

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Retail Payment Systems in New Zealand: Issues Paper

these differences reflect the lower average cost, and greater benefit, that sellers face

from servicing larger buyers.

242. It is therefore to be expected that acquirers would face different costs between

servicing large and small merchants, and therefore that a MSF might be justifiably higher

for a smaller merchant on the basis of these costs. However, it is difficult to understand

why interchange should vary between different sized merchants on a cost basis. This is

because the costs funded out of interchange (principally rewards) seemingly do not

differ based on the size of the retailer.

243. If the spread were to increase further, we are concerned that the competitive

disadvantage faced by smaller firms could ultimately harm retail competition. While we

see the spread in fees as being part of the broader issue relating to the credit card

market, any government intervention to address the issues identified in this Issues

Paper should nevertheless consider the impact on the spread of MSFs.

Do you consider the extent of the difference in the interchange relating to small and

large merchants to be justified?

Box 7: Can MSF pricing be made clearer to merchants?

It was clear in the discussions we had with merchants that there could be greater clarity in

the fees and charges they were paying. Some merchants noted that the information

provided by schemes, banks, switches and terminal providers could be conflicting. There

may therefore be opportunities to ensure that basic information is consistent and correct.

Merchants also noted that some banks do not separate out the cost of credit and debit

transactions, or make clear the impact of accepting contactless payment. These concerns

were shared by both small and large merchants, indicating that scale alone does not ensure

that merchants can understand the information they receive.

We have already noted that merchants are not making use of unbundled rates. While this

could be in part due to a lack of merchant understanding that unbundled rates are available

or potentially advantageous, better information could allow merchants to surcharge or steer

customers more effectively, and better negotiate fees with their acquirer. This breakdown

of information would be useful for these purposes regardless of whether the retailer

chooses to adopt a bundled or unbundled MSF.

It should be noted that while greater transparency would provide merchants with a better

understanding of what they are paying, it is unlikely to resolve the wider issues discussed in

Section 4 above.

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Retail Payment Systems in New Zealand: Issues Paper

Assessment against objectives 4.5

244. The following table summarises the issues discussed so far against the objectives

outlined at the beginning of this Issues Paper, that:

• Objective One: There is innovation and development of payment options that are

valued by consumers and businesses.

• Objective Two: Resources are allocated efficiently at a system level. In the context of

retail payments, this means that the mix of transaction methods used represents the

underlying preferences of consumers and merchants, taking into account the

marginal benefits and costs of certain forms of payment to the system as a whole.

• Objective Three: The cost associated with payment systems is distributed fairly

across consumers and merchants at an individual level.

Table 6: Assessment of outcomes against objectives

Market

Objective One:

Innovation

Objective Two: Allocative

efficiency at a system level

Objective Three: Fair

distribution of costs to

consumers and merchants at

an individual level

Credit

No significant

concerns. The New

Zealand credit card

market benefits from

similar levels of

innovation seen in

overseas jurisdictions.

Significant concerns. The

muted price signals for

credit cards results in a

greater overall cost to the

New Zealand economy

than if there were clear

price signals.

Significant concerns. Firstly,

there is a mismatch of the costs

consumers face, and the

benefits they receive. Secondly,

a consequence of smaller

businesses’ weaker bargaining

power is that they bear a

greater burden of the costs than

larger businesses.

Debit Some concern.

Innovation has been

poor while “free”

EFTPOS was dominant.

The emergence of

contactless scheme

technology represents

an advance but its

entrenchment could

pose barriers to new

entrants.

Growing concern, but

future development

unclear. Around 85 per

cent of debit transactions

remain “free” to

merchants. However, the

emerging dominance of the

interchange business

model could result in

inefficiencies in the future,

as currently seen in the

credit card sector.

Growing concern, but future

development unclear.

Contactless debit is cheaper for

merchants than credit cards,

meaning that any cross-subsidy

is lower. However, if rewards

were to become widespread, or

interchange were to increase,

then our concerns could

increase.

23 Do you agree with our assessment of the two markets against our proposed objectives?

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Retail Payment Systems in New Zealand: Issues Paper

5. Possible next steps

245. This section outlines our preliminary thinking on next steps to address the issues

identified in this Issues Paper. As noted in Section 4, we do not consider that market

forces are likely to resolve these issues. Therefore, we think that some form of

government intervention will be required if these issues are to be addressed.

246. The complexity of the retail payment system and the potential pace of change means

that it will be important for the following to be taken into account when developing a

way forward:

• the New Zealand context;

• the effectiveness and net benefits of each option;

• any consequential impacts on consumers and merchants, investment in innovation,

and development of the broader retail payments sector; and

• the timeliness of any intervention.

247. Should further work be undertaken, it would involve close engagement with

stakeholders, in order to ensure that any proposals make the best use of industry

expertise and take into account any stakeholder concerns.

Immediate actions 5.1

248. We have identified two immediate, industry-led actions that could improve the

transparency of the market as it is currently configured.

5.1.1 Acquirers could provide greater transparency about unbundled MSFs

249. The efficiency of the market could be improved if acquirers were to provide merchants

with greater information about MSFs, allowing merchants to:

• Better negotiate with schemes and acquiring banks on the mix of payment options

and the fees incurred, and gain a better understanding of how fees for particular

payment options compares to the value they derive from them.

• More effectively consider how to deliver payment options to consumers, including

through the use of surcharging and steering.

250. This could put some downward pressure on MSFs for those merchants who have the

requisite bargaining power, and improve price signals to consumers. These are desirable

market outcomes, regardless of any other intervention. However, the impact is likely to

be limited given the other incentives placed on the parties by the interchange business

model. We think that further intervention is likely to be required to address the wider

policy issues.

Would greater transparency have any material benefit for merchants or any other

parties in the system?

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Retail Payment Systems in New Zealand: Issues Paper

5.1.2 Schemes could publicly clarify their intentions in relation to charging for swiped

and inserted debit payments

251. Given the uncertainty merchants face around whether swiped/inserted scheme debit

transactions could one day attract interchange (see Box 5), we think that there would be

benefit in schemes publicly clarifying their intentions about whether or not they intend

to route transactions via scheme rails (and impose a fee on merchants).

Would there be any benefit in schemes publicly clarifying their intentions in relation to

charging for swiped and inserted debit payments?

Further work to address the wider policy issues 5.2

252. While useful, we think that these immediate actions would be unlikely to resolve the

wider policy issues discussed in detail in Section 4 above. We recommend a package of

further work to address the issues that the interchange business model brings to the

credit and debit card markets.

Box 8: Can the Commerce Commission address these issues?

The Commission noted in its evaluation of the 2009 settlement with schemes and banks that

parties had been complying with the settlement agreements, and therefore that they were

likely to be complying with the Commerce Act in respect of the issues that were considered

as part of the settlement. The Commission noted that if there were any residual issues

relating to retail payments remaining, these were likely to be driven by factors other than

non-compliance with the Commerce Act, and therefore alternative regulatory intervention

might be required.

The Commission has also considered the applicability of Part 4 of the Commerce Act, which

deals with economic regulation of firms with a high degree of market power. Under Part 4,

for economic regulation to be applied, there must be little or no competition in the relevant

market, and little or no likelihood of a substantial increase in competition. The Commission

considers that it is unclear whether these tests would be satisfied.

5.2.1 Assess the costs and benefits of applying interchange regulation

253. We consider that the nature and the scale of the inefficiencies in the credit card market

warrants an assessment of the costs and benefits of applying interchange regulation in

the credit market. This would include assessing the impacts of interchange regulation on

consumers and merchants, investment in innovation and any other consequential

effects. International experience indicates that this is likely to be the most effective

mechanism for addressing these issues. Placing a cap on credit interchange rates would

limit the ability for schemes and banks to use the interchange business model to alter

incentives on other parties, where doing so would lead to inefficient economic

outcomes.

254. While the impacts of interchange regulation need to be more formally assessed,

broadly, it would serve to reduce the MSFs paid by merchants, and would likely reduce

the generosity of rewards programmes offered by issuers. While placing a cap on

interchange would not directly impact on the revenues of card schemes, it would likely

impact on the volume of transactions made by cardholders, and could therefore

indirectly affect scheme revenues.

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Retail Payment Systems in New Zealand: Issues Paper

255. Addressing these price distortions could at once improve the value for money that New

Zealanders receive overall in payment services (with the potential to avoid inefficiency

of $45 million per year) and reduce regressive wealth transfers to holders of reward-

offering cards (currently around $59 million per year). Interchange regulation could

support an increase in effective purchasing power for consumers, with the potential for

positive flow-on effects across the domestic economy.

256. The debit market is in a state of transition and it is possible that the inefficiencies

present in the credit market will not develop to the point of warranting interchange

regulation. Nevertheless, the stakes are potentially higher for debit transactions, which

have a larger market share than credit transactions. One option would be for

interchange regulation to only be triggered if certain thresholds – such as a given market

share of scheme debit products or a particular interchange rate – were reached.

257. Interchange regulation would require the establishment of formal regulatory

responsibility for the economic outcomes of payment systems within an existing

government agency. This would address the arguable current gap in the regulatory

landscape, and complement the present roles of the Reserve Bank and the Commerce

Commission in the payment systems space.

26 Do you think that the benefits of interchange regulation are likely to exceed the costs?

27 What unintended consequences could arise from interchange regulation?

28 Under what conditions, if any, should debit interchange rates be regulated?

5.2.2 Barriers to entry

258. We also think there is merit in undertaking a technical study of whether there are

barriers to entry or expansion for new debit payment options, particularly disruptive

options based on developing technologies. In addition to the economic barriers caused

by the interchange business model used by the schemes, there could be additional

barriers relating to:

• The institutions, rules and standards governing payments.

• Any technical constraints resulting from the way the physical and IT infrastructure is

configured.

259. Minimal barriers to entry and expansion would support the viability of products that do

not rely on the interchange business model (and therefore do not produce the

associated inefficiencies).

Aside from the financial barrier imposed by the interchange business model, what

barriers to entry for new debit payment products currently exist?

30 Are there good justifications for these barriers being in place?

31 Are there ways in which any unjustified barriers could be removed?

5.2.3 Investigate other options

260. In addition, we think there could be merit in investigating other options. These include:

• Whether the governance of payment systems can be improved.

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Retail Payment Systems in New Zealand: Issues Paper

• Lighter-touch regulation, such as an industry code of conduct (as in Canada).

• Changes that would be required to make EFTPOS a sustainable alternative to scheme

debit products, including technological improvements.

• Whether the retail payment system, or a part of the system, should be treated like a

utility.

32 Is there merit in exploring options in addition to interchange and barriers to entry?

33 Have we missed any options?

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Retail Payment Systems in New Zealand: Issues Paper

Recap of questions

Section 1

1 Are these objectives for retail payment systems appropriate?

Section 2

Are there any other emerging payment methods that we have missed? If so, what is their

likely impact on the market?

Section 3

3 What explains the decline in the revolve ratio on credit cards?

4 Do you agree with our explanation of the rationale for interchange?

5 Have we accurately described the incentives on parties in relation to interchange?

Why are interchange rates falling for large merchants but increasing for small-medium

merchants?

Is the resource cost data robust? Is the Australian data likely to over-state or under-state

the costs of running New Zealand payment systems?

Section 4

Do you agree with the logic underpinning our assessment that there is inefficiency in the

credit card market?

Do you agree with the logic underpinning our assessment that there are regressive cross-

subsidies in the credit card market?

Do you agree that self-acquirers are unlikely to place downward pressure on

interchange?

How much negotiating power do merchants have over the merchant service fees they

face? Is this likely to change in the future?

Do you think that the issues in the credit card market are of a scale that warrants

intervention? If not, do you think that the size of the issue is likely to grow over time?

Do you agree with our assessment of the incentives held by different parties in relation

to debit card usage?

14 Do you agree that there is little incentive to invest in proprietary EFTPOS?

Do you agree that it is unlikely that schemes will start imposing interchange on

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Retail Payment Systems in New Zealand: Issues Paper

swiped/inserted scheme debit transactions?

Do you agree that merchants facing a per-transaction charge for accepting debit

payments is not an issue in itself?

Is the shift towards contactless debit cost-effective, taking into account the costs and

benefits to all parties in the system?

Do you agree that the lack of price signals in the debit market is likely to lead to

inefficient outcomes of a similar nature to those in the credit card market?

Do you agree that merchant service fees are likely to increase for contactless debit once

acceptance reaches a certain threshold?

Do you agree with our assessment that the interchange business model imposes

significant barriers to entry in the debit market?

21 How do you think the debit market is likely to evolve in respect of these ‘unknowns’?

Do you consider the extent of the difference in the interchange relating to small and

large merchants to be justified?

23 Do you agree with our assessment of the two markets against our proposed objectives?

Section 5