In Card acquiring, Financial Services, Fintech, Payment Services

Payment Systems Regulator’s market review of the card acquiring sector in the UK

The Payment Systems Regulator (“PSR”) is the economic regulator for the £75 trillion payment systems industry in the UK.  According to the PSR, there are six card payment “systems” currently operating in the United Kingdom (“UK”): American Express, Diners Club International, JCB International, Mastercard, UnionPay International and Visa. They are also commonly referred to by the industry as “card schemes”.

To accept card payments, merchants need to buy card-acquiring services. In July 2018 the PSR announced a market review of the supply of card-acquiring services in the UK out of concern that these services may not be working well for merchants and ultimately consumers. The PSR clarified since then that it is interested in providers of these services to UK merchants regardless of where the provider itself is located. Although the PSR’s market review focuses on the supply of card acquiring services for Visa and MasterCard, the card-acquiring services for other card payment systems remain in the scope of this review.

Back in July 2018, the PSR published a first consultation on the draft Terms of Reference (“ToR”) of the market review for industry feedback which was then followed by four further consultations.This is a great example of how UK regulators engage those whom they regulate as well as those who benefit directly or indirectly from their regulatory work in a fully transparent way by providing anyone affected by or interested in the topic with the tools to understand and participate. The reach of their transparent work goes beyond the UK’s borders as they have been known to be at the forefront of many international regulatory developments in numerous sectors but especially in the financial sector.

This note summarises the PSR’s consultations for those who missed them at the time when they were open for comments and would like to catch up with the PSR’s market review of the card acquiring services.

In the draft Terms of Reference (ToR) document, the essence of which was adopted by the final ToR, the PSR explained the following:

  • Notwithstanding the passage of Regulation(EU) 2015/751 on interchange fees (“IFR”) that capped interchange fees on consumer card transactions, it is concerned that acquirers have not passed their savings on to merchants;
  • Its approach to the review will focus on the roles of acquirers and payment facilitators in supplying card-acquiring services; it will not review acquiring services for digital payment methods. It was clarified in the final Terms of Reference that the PSR noted the suggestions of certain respondents that “digital payment methods” should also be included in the scope of the review. However, the PSR decided that for the purposes of this review the “acquiring service for non-card digital payment methods” will not be included as no respondent raised specific concerns about these services. The PSR will however consider (i) any effects of the supply and acquisition of acquiring services for non-card digital payments on the supply of card-acquiring services, and (ii) whether acquiring services for non-card digital payments impose a competitive constraint on card-acquiring services;
  • It will be looking at whether there is effective competition in the supply of card-acquiring services that leads to better services for merchants and consumers. As such, it will look at: 
    • barriers to entry or expansion in the card-acquiring industry; 
    • barriers faced by merchants in switching acquirers; and
    • the lack of services to help merchants make better choices about these services.
  • The outcome of this market review could range from new industry guidelines to an investigation into a breach of the Competition Act 1998. 

The responses by the industry to this specific consultation published by the PSR on its website in January 2019 represent an interesting insight into this sector and they should, in our view, be read by anyone advising, working in or regulating this sector. We decided to extract the following comment from WorldPay’s response which should be duly considered as it, in our view, reflects the overall challenge that the acquiring industry has felt over the years trying to follow changing regulatory definitions of “acquiring” within a complex value chain set-up which is governed not only by laws but also by card schemes rules:

“The proposed definition of card-acquiring services set out in paragraph 1.7 of the Draft Terms of Reference is somewhat at odds with the current industry views and definitions used by other regulators. If the PSR is to review the supply of card-acquiring services to UK merchants, it will need to consider a number of interdependent parties and services, and not just the functions provided by acquirers. As noted above, it is not clear how a market review can meaningfully examine the terms of provision of acquiring services to merchants without full account being taken of the wider and interdependent value chain”.

The PSR responded in its final Terms of Reference that its definition of card-acquiring services uses as a starting point the definition of acquiring of payment transactions set out in the Payment Services Regulations 2017. However, the PSRs 2017 definition also covers acquiring services for non-card digital payments which, as explained above, are outside the scope of the PSR’s review. The PSR further clarified that (i) its definition does not need to replicate any legislation or merger decision – it was created solely for the purposes of its market review, and (ii) that its definition of card-acquiring services does not prejudge the process of defining any relevant market(s). This clarification is certainly very helpful and is noteworthy for the UK payments industry.

In its second consultation, which ran from 8 February 2019 until 1 March 2019, the PSR consulted on its proposed pass-through analysis; namely, by how much the fee charged to the merchant by the acquirer, referred to as the Merchant Service Charge (MSC), has changed for a given change to the “Fees” – which is defined to include “Systems’ Interchange Fees (IF)” and “Scheme Fees (SF)”. On the outset it seems like a challenging task given the various volume and geography related parameters that should come into consideration as they impact the “Fees” charged to the acquirer.

According to the PSR the proposed analysis will focus in the first instance on pass-through from large acquirers to merchants. However, the consultation did not list who these large acquires are, nor on which parameters they will base their selection. In addition, the PSR explained that they may also look at pass-through from acquirers to payment facilitators, and pass-through from payment facilitators to merchants. The results of the analysis will be based on one of several pieces of evidence that will eventually underpin the PSR’s view of how well the supply of card-acquiring services is working. The PSR recognises that the above analysis is by its nature a relatively technical exercise, and they explained in the consultation the econometric approach that they intend to use.

The PRS’s analysis will explore the following questions:

  • What is the long-term pass-through, i.e. change to the level of the MSC resulting from a given change to the Fees, once the MSC has fully adjusted to the change?
  • What is the speed of pass-through, i.e. the speed of pass-through is the time it takes for the MSC to fully adjust to a change in the Fees?
  • Have different broad categories of merchants seen different degrees of long-term pass-through or different speeds of pass-through?

The PSR proposes to explore these questions through an econometric analysis based on a comprehensive data set. This econometric analysis will seek to model the MSC as a function of the Fees and other relevant factors.

In its third and fourth consultations which followed, the PSR consulted on the approach to the merchant survey and the merchant survey questionnaire as follows:

In its third consultation the PSR proposed to organise a merchant survey to collect evidence from a broad range of merchants on the factors that might impact the demand for card-acquiring services. Their aim is to understand how small and medium-sized UK merchants who accept Mastercard-branded and/or Visa-branded cards (the ‘target population’) buy and use card-acquiring services. Specifically, the PSR proposed in its consultation that the merchant survey examines the following:

  • Do merchants have credible alternatives to card-acquiring services for MasterCard and Visa? (for example, card acquiring services for other card payment systems or acquiring services for non-card digital payments).
  • How do merchants access information about card-acquiring services, how do they assess that information, and do they act on it? The PSR proposed to adopt the ‘access, assess and act’ framework to examine the factors that affect merchants’ searching and switching behaviour. This framework is commonly used to analyse demand-side behaviour and identify barriers to switching.
  • How satisfied or dissatisfied are merchants with the quality of service they receive from their provider of card-acquiring services? This includes examining non-price competition between providers of card-acquiring services such as the support merchants receive from their provider of card-acquiring services to comply with the rules set by the card scheme.
  • How does the supply of card acceptance products affect merchants’ choice of card-acquiring services provider? These include, for example, point-of-sale (POS) terminals and gateways. Merchants can buy such card acceptance products from certain providers of card-acquiring services or from third party providers.

The PSR proposed in this consultation to collect around 1,200 survey responses from merchants using structured telephone interviews. The PSR believes this sample size is large enough to give sufficiently precise answers to the questions set out above.

The fourth consultation proposed a template of quite detailed questions which the merchants will be asked during the survey. On perusing the questions for this particular consultation as publicised on the PSR’s website it would seem that the questions still need to be refined and improved on to ensure the desired outcome. In our view, the order of the questions proposed in the consultation should be reconsidered (e.g. the likes of question A8 should be asked at the beginning of the survey). Furthermore, it should be reconsidered if guessing the provider (suggesting that the merchant uses xzy as in question A5) is the right approach as asking a direct question about who the current provider is should be more efficient and less confusing for merchants.

Finally, in the fifth consultation published on 11 July 2019, the PSR consulted on its proposed approach to assessing the profitability in the card acquiring sector. The PSR’s profitability analysis aims to answer the following questions:

  • How profitable is the supply of card-acquiring services generally?
  • How does the profitability of card-acquiring services vary between acquirers?
  • What do any variations in the profitability of card-acquiring services over time tell us about the way that acquirers reacted to the introduction of the Interchange Fee Regulation caps in December 2015?
  • How does the profitability of card-acquiring services vary across broad types of merchant?
  • How significant are other goods and services to acquirers’ profitability?

In this consultation it initially proposed 2 pieces of analysis: (a) Gross Profit Margin (GPM) and (b) Return on Capital Employed (ROCE) for assessing profitability. The consultation closed on 1 August 2019 and following the industry feedback the PSR concluded that it won’t be assessing ROCE. It has concluded that GPM is more likely to provide useful analysis for its review. 

The PSR intends to assess the profitability of the supply of card-acquiring services to UK merchants by comparing the profitability of acquirers to various benchmarks and by considering how profitability has varied over time. The PSR proposed in this consultation to assess the five-year period from 2014 to 2018. Furthermore, the PSR wants to understand how significant other goods and services (i.e. point-of-sale (POS) terminals, payment gateways, cash advances and data analytics) offered by acquirers are for the profitability of acquirers and how they impact on the profitability of card-acquiring services. In the first instance, according to the consultation paper the PSR intends to assess the profitability of the five largest acquirers supplying UK merchants with card-acquiring services. According to the PSR, these acquirers accounted for approximately 90% of card transactions (by both value and number of transactions) acquired in 2018 at UK outlets. The consultation did not however list the names of these acquirers.

The PSR further proposed to issue principles that acquirers will be required to follow in the preparation of their data, to ensure that the information that they provide is the most relevant, reliable and suitable for the purposes of its analysis. To be able to respond, the acquirers may need to disaggregate certain data and/or make adjustments to the way it is allocated. It is proposed that initial data will be collected from the acquirers via one or more information requests using the PSR’s formal information gathering powers.

It goes without saying that this market review, which certain acquirers might see as a further burden into their day to day operations, is having an important impact on compliance, finance and operational finance departments of the acquirers, as they will need to prepare the requested information and data in the required formats and address any related questions.

The interim report on the results of the review is expected in Q1 of 2020.

If you are affected by this market review and/or need advice or guidance, please contact us.