Price setting
7.20 Under HMT’s proposed regulation, operators of payment systems and payment card networks and their members would be licensed by the regulator. It is proposed that licence holders will be required to adhere to principles on efficient and transparent pricing. This section
considers the issues relevant for payment card networks.
7.21 The consultation envisages that prices will be set at the appropriate level to benefit current and future end-users of the payment system.46 7.22 In considering the approach to the regulation of payment card
networks, and in drafting guidance for their regulation, HMT could consider the following principles, together with the EC's proposed regulation, to ensure a consistent approach to regulation that would address concerns in relation to these networks:
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• the possibility of neutrality with respect to the organisational form
48
• the possibility of a materiality threshold
• the possibility of the prevention of tying
• the practicalities of a transparency requirement, and
• the wider options available to cardholders.
7.23 Before discussing these areas in turn, it is useful to consider the price considerations of payment card networks. It was earlier noted that the core role of payment card networks is to bring together consumers and merchants by providing a payment technology that both groups are happy to use and to accept. Payment card networks operate in a two-sided market and face inter-dependent demands from their two types of end-user. Payment card schemes need to consider not only the total price faced by end-users (the sum of the prices faced by
46 In the context of payment card networks, we are interpreting end-users to be both cardholders and merchants. 47 These principles are provided solely with respect to payment card networks.
48 Alternatively the structure of the payment card scheme (while taking account of the effects of scheme rules or
55 OFT1498 cardholders and merchants) but also the balance of these prices
between merchants and consumers. As a result, there are a number of different prices that could be regulated in payment card networks, depending on the desired outcomes from regulation and the approach taken.
7.24 Four-party and three-party schemes have different capabilities to
influence these prices. In three-party networks, as shown in Figure 7.1 above, the scheme is also the issuer and acquirer and so can set the prices for end users (merchants pay and MDR while it is open for cardholders to pay to hold a particular system's card). In four-party networks however, the scheme is not responsible for setting prices to end-users; this responsibility lies with issuers (determining whether consumers pay to hold a particular card, or what incentives could be provided to consumers) and acquirers (determining the MSC). The scheme is able to influence the balance of prices through setting the balance of scheme fees between acquirer and issuer, and by setting default interchange fees and through the adoption of system rules.49
Neutrality with respect to organisational form
7.25 Four-party and three-party networks, at least at the nascent stage, may have the aim of building their network through the optimal allocation of prices between the different groups of end-users
(cardholders and merchants). However, as noted above, the available tools to achieve this are different for each type of network. In three party networks the scheme can set prices directly for cardholders and merchants. In four-party networks the scheme can influence
cardholder and merchant prices through interchange fees, scheme fees and system rules.
7.26 The proposed regulator may wish to ensure that its regulatory approach is neutral to the organisational form or structure of a payment card network. From a competition perspective, it is the balance of end-user prices and the ability of end-users to impose constraints on the pricing of individual networks that is important for their interests (and therefore, given its proposed objectives, the
interests of the proposed regulator). Different payment card networks
49 For example, a rule to prohibit merchants from surcharging cardholders would affect the balance of prices
56 OFT1498 with similar amounts of market power50
7.27 As such, neutrality as to organisational form/structure is compatible with the proposed regulator giving full consideration to the effects on consumers as one type of end user. These effects might differ
markedly across four-party and three-party networks, or between networks of the same type. The proposed regulator might wish to consider whether scheme rules or membership obligations that are equivalent or counterparts across competing networks may
nevertheless be having different effects on the respective end-users of those schemes, when viewed with a number of other factors including the market power and conduct of the scheme operators.
are likely to have the ability to create similar levels of end-user detriment irrespective of whether the network is a three-party or a four-party type.
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7.28 Having made these assessments, and if it is judged that a price-setting intervention is required, the regulator will need to consider at what level to intervene. The regulator will also need to consider whether intervention on the price set is required on both sides of the market, although the analysis below focuses on the price faced by merchants.
One
example is discussed below in the section on the prevention of tying.
7.29 One approach to achieving neutrality across the different types of network would be to regulate MSCs and MDRs. Where price regulation encompasses four-party and three-party networks, this provides the simplest way of ensuring a neutral approach.
7.30 Alternatively, there may be a situation where there are sound
economic reasons for price interventions in four-party networks but not for three-party networks. In such a situation it may be beneficial
50 In considering market power, the proposed regulator would need to take account of whether end-users consider
the cards of a certain scheme to be ‘must carry’ or ‘must take’ products and whether those end-users are able to exercise any credible competitive constraint against increases in cardholder or merchant service charges (for example, by exiting the scheme, or declining to use/accept a card). This analysis of market power might also involve consideration of whether (and to what degree) each group of end-users is able to influence the opposite group of end-users to use/accept the payment mechanism that carries the lowest cost or the greatest benefit. For example, scheme rules might seek to constrain the ability of merchants to steer consumers towards using one brand or type of card over another.
51 It is well established that the same conduct by organisations with different degrees of market power may be
considered to have different effects. For this reason, under competition law, a practice that would be anti- competitive and unlawful if performed by a dominant company may not be anti-competitive/unlawful if performed by a non-dominant company. In regulatory policy, Ofgem’s 2011 guidance on the regulatory regime for gas storage facilities in Great Britain distinguishes between the conduct of market players depending on whether they hold ‘significant market power’.
57 OFT1498 for either MIFs, or a combination of MIFs and scheme fees, to be
regulated, but for MSCs to be left unregulated. Where the acquiring market is sufficiently competitive, this would provide a competitive constraint on the remaining components of the MSC.
Materiality threshold
7.31 The proposed regulator will need to consider the need for a materiality threshold for regulation which would exempt new and small payment card networks from the regulatory requirements.
7.32 It is unlikely that small payment card networks would successfully be able to implement a balance of prices that could harm end-users, as they could exercise a competitive constraint by choosing not to accept the service. Furthermore, there may be economic arguments that justify a balance of prices in a small network that do not apply in larger networks.52
7.33 The consultation document proposes that HMT will have the power to amend the definition of payment systems to be covered by regulation, and to exclude payment systems falling within the definition from regulation. It will be important for the proposed regulator to liaise with HMT to establish clear criteria that strike an appropriate balance
between avoiding barriers to entry and promoting the interests of end- users.
Prevention of tying
7.34 The proposed regulator will need to take steps to ensure that end- users are able to choose freely between different products that are offered by the same organisation.
7.35 Both four-party and three-party networks can use an Honour All Cards Rule (HACR) that is designed to give cardholders a guarantee of
acceptance. This might be unproblematic where a network issues only one type of payment card (or a number of different payment cards that are effectively identical to the merchant, including in terms of the cost of acceptance). However, the HACR might be a cause for concern
52 For example, indirect network externalities, which occur when the value of the network to one set of end-users
increases with the number of the other set of end-users, may be stronger in smaller networks than in bigger networks. The efficient balance of pricing across end-users may be influenced by the strength of these externalities.
58 OFT1498 where a network is able to leverage its market power to introduce a
new, more expensive payment card that merchants are, by the HACR, bound to accept alongside existing cheaper ones. The OFT notes that in the UK, over recent years, there has been a significant expansion in the holding and usage of ‘premium’ MasterCard cards (predominantly branded as ‘MasterCard World’ or ‘MasterCard World Signia’ cards), for which MasterCard sets higher MIFs than it does for standard credit cards.
7.36 The proposed regulator might consider whether the Honour All
Products aspect of the HACR as it currently operates in payment card networks is compatible with the principle of efficient pricing and whether it might need to take steps to prevent any tying of products with different prices that may be considered by end-users as a
combined take-it-or-leave-it offering.
Transparency
7.37 HMT envisages that the proposed regulator will need to produce guidance on how payment card networks will be able to demonstrate that they are complying with price transparency requirements. We note that for many end-users the key criteria for price transparency will include:
• the ability to identify easily, before a transaction is initiated, the costs that the transaction will incur53
• the simplicity of the pricing schedule, including easy
comprehension of the charges and how they break down, including on any statement or invoice, and
• sufficient explanation of the reasons underlying any price increases.54
7.38 In theory, these criteria could apply to both cardholders and
merchants. In practice, given the price of a transaction to a cardholder
53 As part of this, the proposed regulator might wish to consider how readily identifiable (both visually and
electronically) each type of payment card is to the merchant and whether the merchant is able to adequately understand the associated costs of accepting each card before a transaction is initiated.
54 This principle might be particularly relevant where (a) a payment card network has the ability to increase prices
(e.g. increasing merchant service charges by setting MIFs at a higher rate) without the need for any renegotiation of contracts with end-users and (b) where experience indicates that end-users may face such price increases without any apparent additional benefits accruing to them.
59 OFT1498 is usually zero, these criteria are more likely to apply to merchants.
Wider options available to cardholders
7.39 When making purchases, cardholders have a range of payment
options. Often these payment options have costs which are not faced directly by the cardholder (as is the case with free cash withdrawals). The regulator will need to consider the extent to which it is
appropriate and possible to take account of the price signals of other payment options when considering any price intervention in relation to payment card networks.
60 OFT1498
8 APPROACH TO REGULATION
Introduction
8.1 In establishing a new regulator, it is important to consider the